As we enter 2015, one of the most exciting emerging industries for investors is solar energy. The industry has been embattled for much of the past decade, but it's now competitive with fossil fuels without subsidies in many parts of the world, and over the next few years more and more markets will become economical.
For investors, there are a number of ways to play the industry, from solar manufacturers to fully integrated companies.
SunPower's 21.5% efficient solar module leads the solar industry. Image source: SunPower.
The solar manufacturers
For years, investors have been avoiding solar panel manufacturers. The industry is often viewed as a commodity industry, but the narrative is starting to change as investors and consumers begin to understand solar technology.
SolarCity's (SCTY.DL) decision to buy Silevo, maker of higher efficiency solar modules, validated SunPower's (SPWR -2.17%) high efficiency position, and First Solar (FSLR -2.09%) is putting all of its effort behind increasing efficiency. Put another way, manufacturers who make high efficiency solar panels have seen profits rise in the last two years, while lower tier, low efficiency module makers are still reporting losses.
If you're looking at solar panel manufacturers, the two companies I will highlight are SunPower and First Solar. SunPower is the known commodity because it makes the highest efficiency panels in the industry and is also involved in nearly every downstream market (which I'll cover below).
First Solar has long been one of the most profitable solar manufacturers in the industry, but has recently fallen behind even commodity Chinese panels on cost per watt and efficiency. But it's doubling down on technology in an effort to increase conversion efficiency to 17.2% by the end of 2017. This won't bring it within shouting distance of SunPower's 21.5% efficient panel already in production, but it'll allow the company to maintain competitiveness on utility-scale projects where it thrives.
SolarCity has expanded into commercial rooftops like this one. Image source: SolarCity.
The solar installers
One big change in the last two years has been the emergence of solar installers, which buy panels, inverters, and other components from other manufacturers.
SolarCity has been the most visible of these installers, taking the country by storm with its growth in residential solar. Vivint Solar (VSLR) is a competitor that went public this year and has been on a growth tear in an effort to catch up to SolarCity. It's more of an installation pure play, while SolarCity vertically integrates nearly every part of the supply chain. SunEdison (SUNEQ) is another company that has grown largely by installing solar systems, large and small, and not being a manufacturer.
What's interesting here is that many manufacturers are also becoming installers. SunPower and First Solar are two of the largest solar installers in the world, and companies like Trina Solar, Canadian Solar, and JinkoSolar are investing heavily in expanding their installation businesses. Before long, most companies may be vertically integrated.
I wouldn't buy any solar company that doesn't at least have a hand in the installation market. Even if you make the best solar panel in the world, it's not going to create as much value for shareholders as a great installer of solar projects. That's where the money is today, and many in the industry are adapting to that reality.
Residential solar systems like this one are just one end market for SunPower. Image source: SunPower.
The integrated solar installer
As I mentioned above, the lines are blurring between solar manufacturers and solar installers, creating a whole new category in the solar industry, the integrated solar company.
It's here where investors should be focused, but they need to understand where different companies stand. First, they need to understand what is vertically integrated and what isn't. For example, SolarCity does installation, financing, racking, and sales, but it won't make its own solar panels for at least two years. SunPower makes panels, does financing, and builds its own commercial and utility scale projects, but it doesn't install residential systems itself, instead relying on partners. First Solar is vertically integrated in the utility segment, but doesn't compete well in commercial or residential solar.
There's also geographic diversity to consider. With the investment tax credit expiring in 2017, there could be a huge drop in solar installations in the U.S., something we've seen in the solar boom and bust cycle around the world. SolarCity and Vivint Solar are two companies which are reliant on the U.S. and offer no diversity to investors.
SunPower, First Solar, and SunEdison offer diversity in a number of end markets, mitigating subsidy and policy risk in any one location.
The top solar stocks of 2015
When looking at the solar industry, I think it's wise to choose a basket of stocks with diverse business models rather than betting on a single company's success. On the manufacturing side, I'd choose the solar manufacturer with a discernible competitive advantage in efficiency and the most diverse end markets in the industry: SunPower.
In the residential solar industry, I like Vivint Solar's growth in the past year and the discount investors are getting versus SolarCity. Its focus on the U.S. is a risk, but the company has the ability to double installations through 2016 and still manage to weather the storm when the investment tax credit expires.
In utility-scale solar, no company has the long history of profits that First Solar has. Its risk is in falling behind from an efficiency standpoint but it spends more on R&D than anyone else in solar and I think it can execute on efficiency improvement plans. If that happens, it could keep its role as one of the most profitable companies in the industry.
A basket of these three stocks will provide investors exposure to solar in 2015 without putting all of their eggs in one basket. That's the best way to play solar today.
