The solar rally may finally be upon us. As you can see below, the biggest names in solar have gone on a tear in the last three months. First Solar (NASDAQ:FSLR) and SunPower (NASDAQ:SPWR) are up over 50%, while two of the largest suppliers in the industry, JinkoSolar (NYSE:JKS) and Canadian Solar (NASDAQ:CSIQ), are up double digits as well.
What's driving solar stocks is a little less clear. Donald Trump may have started this rally, but it's the solar industry itself that will keep it rolling. And there's good reason to think solar stocks may still be vastly undervalued, even after their recent run.
Trump is a distraction, for now
The latest pop in solar stocks was driven by Donald Trump's talk about the border wall, which could potentially include solar panels. If the wall does get built and a company like SunPower or First Solar supplies the panels, it could be a nice boost in demand for either manufacturer.
But betting on the wall is speculative, especially when you consider that neither SunPower nor First Solar makes most of its solar panels in the U.S. For now, Trump's solar wall is a distraction from some truly positive developments in solar.
Balance sheets are improving
The first notable change in solar companies' fortunes is that the value of solar projects seems to be on the rise. And for First Solar, SunPower, and Canadian Solar, which hold projects on their balance sheets right now, that increased value should help their finances in 2017.
Rising project values also are coinciding with First Solar's and SunPower's move to a business model that will have them building fewer projects themselves, focusing instead on solar-solution sales, including panels, racking, and other components. Long term, the business-model transition should lead to a lighter balance sheet, with a higher turnover of revenue compared to assets.
Solar manufacturers are figuring out where they stand
Part of the rationale for the business-model change by First Solar and SunPower is that they realize they're not the best owners for solar projects long term. As utilities and investment firms more aggressively bought projects, it became clear that solar developers didn't have the low-cost capital needed to stay in the ownership game, whether it was through a yieldco or their own balance sheets.
The simplified model of selling components should allow manufacturers to expand production and sell to a broader set of customers. We've seen First Solar and SunPower both start upgrading solar manufacturing, and they could expand rapidly if their new strategies are successful.
Growth is on the horizon
One of the biggest reasons solar stocks took a nosedive in 2016 was the anticipation that 2017 and 2018 would be relatively weak years for the industry. There was uncertainty regarding China's solar plans, and the U.S. was reeling from a flurry of projects built in anticipation of the investment tax credit (ITC) ending in 2016. (The ITC was eventually extended.)
As 2017 has gone on, installations have been a lot better than anticipated, and the industry is expected only to grow from here. GTM Research predicts that installation will grow from 85.4 GW in 2017 to 110.1 GW in 2022, with steady growth beyond 2019. And I'll point out that GTM and almost every other solar prognosticator has underestimated the industry's growth in the past, so growth could be much higher than that forecast presumes.
If the solar industry's growth coincides with strong companies like First Solar, SunPower, Canadian Solar, and JinkoSolar consolidating power and increasing market share, we could see significant growth from each company. First Solar and SunPower, in particular, could go from around 3 GW and 1.5 GW in production, respectively, to 5 GW to 10 GW in 2022, if they hit their own growth plans. And that leaves a lot of upside for investors.
Solar stocks could be a steal
Sometimes, after stocks go on a run of 50% or more in a short amount of time, it's a sign to sell. But in the solar industry, I think the market is just starting to see the potential for future growth.
A few weeks ago, I projected the value of First Solar and SunPower based on their own production plans and finances. And it's not inconceivable that both could be making $1 billion in gross profit within five years, with lots of opportunities to grow from there.
And for companies with market valuations of $4.1 billion and $1.3 billion, respectively, First Solar and SunPower could still be vastly undervalued. I'm less bullish on Chinese manufacturers Canadian Solar and JinkoSolar given the commodity market they serve, but a rising tide could lift their fortunes, as well.
This solar run just may be starting, particularly if financial results start to improve. 2017 will be a volatile year for solar stocks, but the winners in this industry long term will be worth holding onto for a long time to come.