Recently I wrote about the $6.4 trillion investing opportunity that is renewable energy, in which I explained the dangers and difficulties investors face when investing in this exciting, but speculative, sector.
As this chart shows, despite the large long-term promise of the solar industry, investors must take special care when investing in this industry, as it's extremely difficult to value fast growing companies that aren't likely to turn a profit for many years.
I feel such a warning is apt for Wall Street's most recent darling, SolarCity (SCTY.DL). Due to deep concerns over the company's business model and future capital expenditure plans, I recommended against owning the company in my last article. However, there are two solar companies that I believe could make good long-term investments at today's prices.
The two solar stocks worth owning
First Solar (FSLR -2.09%) is the world's leader in thin film solar panel technology, delivering 14% average cell efficiency (panel efficiency is usually 1%-2% lower).
Year to date, the company has 3.2 gigawatts of panels scheduled for delivery which are expected to result in $7.6 billion in revenue. First Solar is also working on 12.7 GW of potential bookings, which represents several years' worth of projects.
Another reason to like First Solar is its strong balance sheet. The company has $1.35 billion in cash and only $196 million in debt, and it sports a current ratio of 2.62.
The current ratio is the ratio of existing assets to existing liabilities and represents a quick and dirty way of evaluating whether a company can pay its short-term obligations -- which First Solar should have no problem doing.
The next reason I like First Solar is that 28% of shares are held by insiders, indicating management's interests are closely aligned with those of shareholders.
Finally, an important consideration when investing in solar is the company's diversification. First Solar sells panels and builds utility scale solar projects in locations including North America, Latin America, Japan, Europe, the Middle East, India, and Australia.
Source: SunEdison Investor presentation.
As this chart from competitor SunEdison (SUNEQ) shows, roughly $1 trillion of solar installations are expected globally from 2012 to 2020, with the United States representing only a small fraction of that total. That's key because, as I explained in a recent article, the federal solar Investment Tax Credit, which allows a 30% tax deduction of a solar system's cost, is set to decline to 10% for businesses that own their systems and 0% for residential solar projects at the end of 2016. This tax credit currently funds 40%-45% of the installation cost of solar systems, and if it isn't extended the growth rate of U.S. solar projects could fall off a cliff.
First Solar's diversification around the globe, as well as its profitability and strong balance sheet, greatly increase the chances of the company surviving changes in tax incentives in any particular country -- and avoiding the same fate as GT Advanced Technologies. This is especially true with interest rates expected to rise and drive up borrowing costs over the next few years.
Finally, I'd like to point out the excellent work First Solar is doing in advancing solar technology. For example, this year First Solar set a world record for thin-film cell level efficiency of 21%.
This result shows First Solar's commitment to research and development, not just in terms of efficiency, but also when it comes to decreasing the cost of solar systems. Specifically, First Solar decreased its cost per watt 11% in 2013, and by the end of that year had achieved a cost of just $0.53 per watt at its best factory -- an additional 10% cost reduction. This not only means the company should maintain or even expand its margins, but also increase its competitive advantage by offering customers cheaper solar systems.
SunPower (SPWR -2.17%) is the other solar company I recommend, and it shares many positive traits with First Solar. It's profitable, with an exceptional return on equity, indicating management is very good at using shareholder capital to generate value for investors.
Its balance sheet, while not as strong as First Solar's, is solid nonetheless, with $981 million in cash versus $1.22 billion in debt and a current ratio of 1.84. With an annual levered free cash flow of $103.5 million, SunPower should be able to weather the kind of economic or industry-specific storms that would bankrupt many other solar companies.
In terms of management's interests being aligned with shareholders', SunPower's 66% insider ownership is among the highest I've seen of any company.
Source: SunPower Q2 Investor presentation.
In addition, as this chart shows, SunPower plans on taking advantage of the global boom in solar by expanding production by 57% between 2013 and 2016. It is also continuing to work to increase the efficiency of its solar cells; this is important because superior efficiency can often result in superior long-term cost advantages.
SunPower's more efficient panels can cost 35% more up front, yet result in 25% cheaper electricity per kilowatt hour. This is especially important to utilities, which plan energy-generating investments on time scales of decades and to whom the lowest long-term cost is paramount.
This efficiency and long-term cost advantage is why Berkshire Hathaway (BRK.B 0.54%) looked to First Solar and SunPower to build $6 billion of its own solar investments.
Finally, SunPower, just like First Solar, is diversified around the globe. It is working on over 350 projects totaling over 8 GW of solar capacity in over 30 countries on six continents.
That diversification ensures that, even should regulations or tax credits change in any one country, SunPower shouldn't face a bankruptcy-inducing loss of business.
The solar industry represents one of the largest investment opportunities in the world today, yet also one of the most dangerous. It is an industry rich in speculative companies trading at generous valuations and, all too often, unrealistic growth assumptions. I would recommend that prospective solar investors consider First Solar and SunPower as the "blue chips" of this industry.
Not only are these two companies solidly profitable, with industry-leading operating efficiencies, but their balance sheets are strong enough to weather economic storms that could bankrupt some of their competitors. In addition, they have the financial resources and commitment to R&D to lead their industry in terms of efficiency gains and long-term cost reductions, which makes it more likely that major utility customers around the world will turn to them for their future solar needs.
