3 Reasons SunPower Will Dominate Solar

Don't look now but SunPower (NASDAQ: SPWR  ) has become the best-performing stock in the solar industry. Over the past year, it's been better than fellow U.S.-based companies First Solar (NASDAQ: FSLR  ) and SolarCity (NASDAQ: SCTY  ) , and far better than most Chinese manufacturers. Yingli Green Energy (NYSE: YGE  ) and Trina Solar lag well behind even after recent pops higher; only Canadian Solar (NASDAQ: CSIQ  ) can come close to SunPower's return (and I'll get into the reason for that below).

SPWR Total Return Price Chart

SPWR Total Return Price data by YCharts

So, why is this stock so hot and can the streak continue? I think so, and there are three big reasons why.

Downstream solar is the dominant paradigm
If you have the choice between risky solar manufacturers and a downstream installer, it's better to choose the installer right now. They can lock in long-term power supply agreements, building a business that acts more like a bond than a volatile stock. SolarCity has used this model with success, and despite the fact that it isn't reporting a profit yet, it's building solar installations that will generate revenue for 20 or more years.

The same can be said for utility-scale solar, where First Solar dominates. Companies can build projects and sell them off to investors like Warren Buffett -- who has bought projects from both SunPower and First Solar -- or own them and generate long-term cash flow. The latter option is best in the current environment, but if REIT and MLP models are opened up to this industry, that trend may change. 

It's expanding in the downstream market that has put Canadian Solar ahead of competitors as well. It's building demand for its own panels and raising margins as a result. 

But, if you want exposure to residential solar and utility solar there's no better company than SunPower. It is one of the largest utility-scale installers in the world and has a concentrated product, called C7, that could drive the next generation of growth. In residential and commercial solar it's smaller than SolarCity, but it projects more profitable installations and is growing quickly.

Efficiency vs. cost
There's still a lot of debate over whether efficiency matters beyond a certain point in solar. Clean Power Finance CEO Nat Kreamer, who helps line up financing for residential and commercial projects, thinks that a more efficient panel isn't worth the cost in today's market and a standard efficiency product is good enough. That may be true today, but investors also need to think about tomorrow's market.

Over the last few years it's become very evident that it's easier to cut costs in solar than it is to increase efficiency. First Solar once dominated the industry with a low-cost, low-efficiency panel and; it's now had to buy a solar start-up to get into the high-efficiency market. Even if SunPower is making a product that's more costly and more efficient than the residential market needs, I would rather buy that and bet on rapidly falling costs than on the improving technology of commodity solar panels. Chinese players like Trina and Yingli spend almost nothing on R&D and aren't likely to increase efficiency more than incrementally in the next few years, so it's much more likely that SunPower will cut costs than increase efficiency. 

Profits and balance sheets matter
Even if efficiency doesn't matter as much as I think it does, investors will want to buy companies that are making money long term. SunPower increased its non-GAAP gross margin to 22.7% in the first quarter of this year and expects to make a profit on a GAAP basis this year as well.  

On the balance sheet, there are few companies in solar who are its equal right now. SunPower has $142 million of net debt compared to the billions of dollars in debt for Yingli, LDK Solar, and Suntech Power. Even leading balance sheets of Chinese companies, like those of Canadian Solar and Trina Solar, are loaded with debt, and these companies are losing money rapidly each quarter.

SunPower has a better balance sheet than its competitors, which leads to a more reliable warranty and higher margins.

Foolish bottom line
When you consider that SunPower has a better income statement and balance sheet than its competitors, and has a stronger strategic position both in the upstream and downstream markets, it's easy to see why I think this is one of the long-term winners in solar. Over the past year, that's been manifest in the best returns for investors in the industry and, as the company separates further from the pack, I think that trend will continue.

Add on top of all of the factors above that EU tariffs are hitting Chinese manufacturers this quarter and that the Chinese government has said it will allow companies to fail, the result is that there's a lot of risk investing in Chinese solar manufacturers. I'll take the safety of investing in a company that has many solid advantages over its competitors, than speculate on who might survive the industry in China and what U.S. shareholders may be left with in the end.

What about First Solar?
Investors and bystanders alike have been shocked by First Solar's precipitous drop over the past two years. The stakes have never been higher for the company: Is it done for good, or ready for a rebound? If you're looking for continuing updates and guidance on the company whenever news breaks, The Motley Fool has created a brand-new report that details every must know side of this stock. To get started, simply click here now.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 20, 2013, at 8:42 PM, ronwiserinvestor wrote:

    Solar module efficiency is practically meaningless when it comes to real world performance. If you have sufficient space on your roof to accomodate lower efficiency solar modules then there is no difference in energy production. A 300 watt high efficiency solar module like SunPower puts out nearly the same 300 watts as a 300 watt lower efficiency module. The only difference is the physical size of the module and of course price. So if you have sufficient roof space, why on Earth would you pay SunPower's much higher price per watt? SunPower dealers play a game of semantics. They tell consumers that SunPower manufactures the most powerful solar modules in the world which leads consumers to think that somehow they'll get much more power out of their system when compared to other equally sized lower efficiency solar systems. The end result is almost the same amount of power per day as a lower cost, lower efficiency solar module. Save your money and invest in the highest efficiency inverter that money can buy. Inverter efficiency make a big difference solar module efficiency is practically meaningless.

  • Report this Comment On June 21, 2013, at 3:13 AM, UKGary wrote:

    There are several reasons to want higher efficiency panels even at a premium price.

    1. Module efficiency has a huge impact on balance of system cost.

    Any panel of a given size other factors being equal takes the same amount of time, support rail, cable, and clips to install. A high efficiency panel like that of Sunpower balance of system therefore costs significantly less per watt than standard panels.

    2. In certain markets, especially the USA and Japan, "soft costs" form a very large part of the installation price. Soft costs are things like permitting (planning and grid connection), and inspection. These costs are pretty much fixed for a given array application whether it is for 3 kW of standard panels or 4 kW of high efficiency panels on the same footprint.

    The end result is that total system cost per installed watt can be lower for the higher efficiency panels than the standard panels even though the panels themselves are more expensive.

    3. Very high efficiency panels generally have a better temperature coefficient than standard panels meaning that their efficiency is less affected by heat resulting in perhaps 5 to 10% more annual kWh per kW of installed array especially in hot regions.

    4. Opportunity cost - for any given site, there is a finite amount of space on which to place solar panels. If you use low efficiency panels, you have to settle for installing less capacity than would otherwise be possible.

    5. From a manufacturing point of view, high efficiency panels have greater potential to reduce their cost per watt than standard panels as a larger proportion of their cost is represented by the R & D cost and start up costs of a new manufacturing process. Meanwhile the actual materials cost per panel is similar to any other panel - so less raw material cost per watt.

    Sunpower has now reached a point where its R & D costs and initial capital costs can be divided over a rapidly increasing volume of product - the so called learning effect. This works faster for new products than for older products which given lower materials costs per watt allows the more efficient product to close the manufactured cost gap with standard product. For this reason, in terms of manufactured cost, it is possible even likely that Sunpower will match the manufacturing cost of standard panels before to much longer.

  • Report this Comment On June 21, 2013, at 7:52 AM, clanza875 wrote:

    So we've established SPWR to be the greatest thing since sliced bread yet no one can possibly explain their reconciliation from substantial GAAP losses to nonGAAP earnings.

    They're still losing $50 million a quarter on a GAAP basis and until that changes this looks like one very expensive stock.

  • Report this Comment On June 21, 2013, at 10:46 AM, UKGary wrote:

    Right now, virtually every solar manufacturer is losing money as the scale of production facilities has expanded faster than the market, and manufacturers desperate for market share have been dropping their prices to maintain sufficient short term cash flow to stay in business.

    I would say that this process has now gone as far as it can, and that end user prices now appear to be stabilizing - so giving production cost reductions a chance to catch up with reduced selling prices. (In which area Sunpower is in a very strong position in terms of its potential to reduce costs faster than the rest of the market.)

    Sunpower is in the fortunate position that high efficiency modules are strongly favoured in both Japan and the USA which are substantial and fast growing markets for the technology, and by engaging in both manufacturing and deployment of solar panels, there is still a profitable side of the business to keep them going until they can get the manufacturing side into profit.

  • Report this Comment On June 24, 2013, at 3:19 PM, yovinman wrote:

    "Solar module efficiency is practically meaningless when it comes to real world performance."

    Wrong, wrong, wrong! This person has obviously never installed a solar panel or has been on a roof. I have. Panel efficiency makes a huge difference. It's all about kWh production and not just the kW rating of the system. SunPower panels produce more electricity throughout the day because they react to a broader spectrum of sunlight, they perform better in high temperatures (heat is an enemy of solar production), and they make more electricity throughout their lifetime because their performance degradation is much, much lower compared to cheap, less-efficient solar panels. All this translates into more electrical production for same rated system. Think about it this way, 2 cars from different car makers with the same rated engine size can have vastly different gas mileage. Electrical production and not the power rating is the name of the game in solar. If you don't know the difference, then do more research to understand this before you invest in solar.

  • Report this Comment On June 24, 2013, at 5:26 PM, sonofTesla wrote:

    In the words of the brilliant Elon Musk: It is not wise to bet against the Chinese with regard to manufacturing"

    Yingli (YGE) is a far better buy and on the verge of signing one of the largest deals in the history of the solar industry...3GW direct from China. Much better bang for you buck with this stock...and Travis, as you can clearly see (or maybe not) the largest (by a large margin, and fastest growing installer in on of the fastest growing markets (the US) almost exclusively uses Trina and Yingli panels...I wonder why....If SPWR were so dominant, why isn't Solar City using them.

  • Report this Comment On June 25, 2013, at 11:26 AM, SolarJoe12 wrote:

    The other issue in this discussion is warranty. Sunpower provides a 25 yr product warranty on their panels, compared to 5 or 10yrs on every other product. In addition, Sunpower provides a better "power production" guarentee. The industry standard, government mandated requirement is 90%/1st 10 yrs - 80% to25 yrs. Sunpower's guarentee is 95% - 85%.

    Yoviman is also correct about overall energy production. Sunpower panels typically produce 8-10% more energy than their "rated" watts for all the reasons he states.

    Research for yourself at http://www.youtube.com/user/RevcoSolar1

  • Report this Comment On August 24, 2013, at 11:20 AM, Solaire06 wrote:

    Totally agree about the efficiency of SunPower panels. When I decided to create my own installations, 4 years ago, I really trusted about the argument of SunPower.

    If I were to do it again, my choice will be Sanyo pannels, for a simple reason: HEAT!

    These pannels coul be very interesting in the North pole for a small cabin, but in the real world pannels are exposed to the sun, that not only enlights, but also heats any surface.

    My experience is that during summer the pannels go down in production, to fall to a miserable chinese equivalent, costing not even half of the SP price.

    This is again a marketing trick to talk about curves and percentages, instead of looking to the day to day life results, and it's not so brilliant...

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