A global push toward cleaner sources of energy combined with falling costs is leading to continued growth for renewable energy. The U.S. Energy Information Administration projects that, by 2050, renewables will be the world's most-used energy source and will generate nearly half of the world's electricity. Moreover, among renewable energy sources, solar energy's share is expected to grow the fastest. If you want to invest in the future of energy production, here are two top stocks to buy to ride on the solar wave.
Canadian Solar (CSIQ 1.24%) is a geographically diversified manufacturer of photovoltaic modules (or solar panels) with operations in 23 countries. Over the last 10 years, the company has grown its revenues by an impressive average annual rate of more than 20%. Similarly, its margins historically have been stronger than its peers.
As the above graph shows, Canadian Solar's average gross profit margin over the last three years has surpassed its top peers. The company's differentiated market strategy with a focus on premium rooftop segment gives it pricing power and is a key driver of its higher margins.
In July, Canadian Solar announced its intention to list its Module and Systems Solutions subsidiary on the Chinese stock market. The planned listing will provide it with an access to additional low-cost capital while not burdening its balance sheet. The company plans to use the proceeds for capacity expansions and increased vertical integration.
In addition to the planned capacity expansion and vertical integration efforts, Canadian Solar's major potential growth driver is energy storage products. Storage products help align energy demand with supply and are expected to markedly improve solar energy's prospects compared to traditional energy sources. For that reason, the demand for storage products is expected to rise substantially over the coming years. With an impressive storage projects backlog, Canadian Solar looks set to benefit from this massive potential demand. Finally, the stock is priced less expensively than its peers based on PE and EV-to-EBITDA ratios.
Solar module manufacturers face intense competition, especially on pricing, which has the potential to squeeze margins. This risk could be one of the reasons behind Canadian Solar's low valuation. Investors may suspect that the company's peer-leading margins may not last forever. However, Canadian Solar has fared extremely well so far in an increasingly competitive market. Time will tell whether it can maintain that performance, although past performance suggests it can.
Solar energy surely has massive growth potential. However, the market is rapidly evolving and the stocks in the sector can be quite volatile. Governmental incentives and policies can impact solar companies' profitability significantly, as happened in 2017 and 2018. Considering their erratic performance so far, it's best to take a long term approach with holdings in your solar portfolio.
With a history going back over two decades, SunPower (SPWR 2.46%) has been innovating and experimenting long enough to figure out what works and what doesn't in the solar industry. The company has done it all -- from producing microinverters to solar panels to installations to financing. It has now concluded that the best way to generate higher margins is by offering high-quality products and making it convenient for customers to buy them.
In contrast to the popular strategy of vertical integration to lower costs, SunPower is moving to become a specialized player focused on solar technology. The company's logic is that this will help the company to generate higher margins. In November last year, SunPower announced its plan to spin-off Maxeon Solar (MAXN -3.53%), which produces solar modules. It completed the spin-off in August this year.
SunPower will continue to source modules from Maxeon, similar to the way it sources microinverters from Enphase Energy. It gets installations done through its network of dealers and sells a major chunk of its products through loan or cash sales rather than financing them itself. This capital-light strategy of sourcing, rather than producing on its own, puts a minimum strain on SunPower's balance sheet and allows the company to focus on innovations. SunPower has posted decent results so far in 2020, with improved margins despite lower revenues due to COVID-19 and the Maxeon spin-off.
SunPower's key strength is its huge customer base, which it can also leverage to sell storage products. The storage products market remains underpenetrated, and the potential for growth is massive. The company is making good progress in the storage solutions segment with its product SunVault. SunPower expects SunVault to generate $100 million in revenue in 2021. The company expects more than 25% of all its residential sales and 30% of its commercial sales in 2021 to also include storage products. That would be significantly higher than 2020, when just 11% of its modules had storage products attached.
On average, storage products contribute $0.16/watt of margin. The company's blended average margins for residential and commercial products, just 11% of which had storage products, was around $0.31/watt in 2020. Therefore, storage products are expected to improve SunPower's margins meaningfully.
SunPower is the number one solar provider in the commercial segment. The company is poised to benefit from huge growth in the untapped residential market as well. Only 2% of homes in the U.S. currently have solar installations. New homes provide another potential growth opportunity. Solar capacity on new homes in California, which has the highest solar adoption in the U.S., is expected to triple by 2025. SunPower has a market share of more than 50% in California's new homes market.