Renewables are the fastest growing energy source in BP's Energy Outlook to 2035. The Energy Information Agency predicts an even higher yearly growth rate of 9.8% for U.S. solar until 2040. Right now you can buy many solar manufacturers for around 1.5 times sales, which is a great deal considering the growth the sector is about to see.
The industry's barriers to entry are growing
Any profitable market with a healthy future needs substantial barriers to entry. Barriers to entry help to eliminate competition and decrease margin pressure. Every year the complexity of solar manufacturing increases as research and development spending increases barriers to entry.
SunPower (SPWR -0.77%) has more than 80 patents and uses innovative manufacturing techniques to create high-quality panels that degrade slowly. First Solar (FSLR 0.41%) recently inked a deal with GE where it will take ownership of a significant number of GE's solar patents, boosting First Solar's technological advantage over second-tier manufacturers.
China is smartening up
The Chinese government has realized that oversupplying the solar market with low-quality panels helps no one. To help clean up the industry, reduce excess capacity, and improve margins, Beijing has decided that it will only support a limited number of companies in the solar industry. It recently made a list 134 companies that will receive government help. Some companies like LDK Solar (NYSE: LDK) did not make the cut, but others like Yingli Green Energy (NYSE: YGE) will continue receiving government support.
Grid parity is coming
Deutsche Bank estimates that 75% of the world's solar will be cost competitive with few or no subsidies by the beginning of 2015. Every quarter solar manufacturers move closer to the point where they don't need to convince governments to provide subsidies or renewable energy targets.
Solar has become so cost competitive that SunPower already signed a deal for a 70 megawatt (MW) Chilean plant that will sell directly to the spot market without government subsidies. First Solar has also been trying to get more involved with the Chilean market after its acquisition of Solar Chile's 1.5 gigawatt early stage pipeline. Yingli has expanded its Latin American operations as well, growing its customer base in the region by 15% in the third quarter of 2013.
Solar is becoming profitable
In the last four quarters, SunPower's earnings before interest, taxes, depreciation, and amortization have recovered from about $-44.8 million to approximately $141.5 million, and its basic earnings per share went from $-1.23 to $0.89. In the last four quarters, First Solar saw its EBITDA improve from $257.4 million to approximately $322.1 million, and its basic EPS has grown from $1.78 to $1.98. These numbers prove that the industry is healing.
Yingli is one of the stronger Chinese solar manufacturers. In the last four quarters, its gross profit grew from $-39.8 million to $81.5 million. The improvement in Yingli's gross profit comes in part from its growing U.S. volumes.
The difference between Yingli and LDK Solar could not be bigger. LDK missed debt payments back in August, and now Beijing's lack of support could be the nail in its coffin. If you want to protect your capital, you should avoid LDK at all costs.
Now is the time to invest
The solar market is not very difficult to understand. Solar energy is becoming cheaper while fossil fuel costs are rising. SunPower and First Solar have seen their income statements improve substantially in the last year. Continued technological development is increasing barriers to entry in the solar industry, giving top-tier manufacturers more security. Renewable energy as a whole is expected to see a global annual growth rate of 6.4% until 2035.
First Solar and SunPower are good companies to consider thanks to their growing profitability and advancing technology. Yingli comes in second place, as it is stuck in the middle of the oversupplied Chinese market. Finally, until a bigger portion of the Chinese manufacturing capacity is declared obsolete and LDK starts posting positive net income, it is best to ignore LDK.