Editor's note: A previous version of this article overstated the efficiency of First Solar and SolarCity panels. The Fool regrets the error.
SCTY data by YCharts
Solar stocks such as First Solar (NASDAQ:FSLR), SunPower (NASDAQ:SPWR), and SolarCity (NASDAQ:SCTY.DL) have been some of the hottest stocks of the last 18 months.
With a market potential of $2.2 trillion and the International Energy Agency estimating that $2.55 trillion/year will need to be spent on total energy and efficiency infrastructure through 2035, one can understand why Wall Street has fallen in love with these companies.
However, at The Motley Fool we believe in a long-term buy and hold strategy of great companies with strong growth prospects. This article will look at these three solar companies and attempt to answer the question: Can long-term investors still make money at these prices?
First Solar: profitable but too big to grow
First Solar is the largest solar company by market cap and production capacity, shipping 2.7 gigawatts (GW) of solar panels last year and guiding for 2.8 GW in 2014.
There are three main problems First Solar faces: its large size, inferior technology, and share dilution.
First Solar has just secured financing to build the largest solar project in Latin America, the Luz del Norte power plant in Chile, which will be 141 MW. In 2013 Chile's economy grew at 4.1% and it faces the challenge of expensive electricity. Its government has set a goal of 20% solar power generation by 2025 to help the economy grow while lowering power costs and cutting carbon emissions. The reason for such a bold goal? Chile is blessed with some of the best solar potential on earth with its Atakama desert experiencing the highest solar radiation levels on earth. First Solar won the contract because it uses Cadmium thin-film panels which handle extremes of temperature better than silicon panels.
But if First Solar is doing so well in a promising market like Chile, then why the negative earnings growth projections? The answer lies in scale. The Luz del Norte project is 141 MW, representing strong growth for Chile's solar industry, which installed just 150 MW in 2013.
However, given First Solar's massive scale, even a couple hundred MW won't move the needle and First Solar's thin-film panels are only 13.5% efficient compared to 21-23% for SunPower panels and 15-17% for SolarCity's panels.
Chile's extreme climate may call for thin-film panels, but the majority of the world cares more about efficiency, which directly affects cost.
Finally, First Solar, like SunPower and SolarCity, faces the problem of large share dilution.
FSLR Revenue (Annual) data by YCharts
As seen above, all three companies have high annual dilution rates:
- First Solar: 9.7%
- SunPower: 6.3%
- SolarCity: 13.8%
With First Solar's revenue growth stalling due to its large size and inferior technology, the company's high dilution and slowing growth means the share price will struggle to grow over the next decade.
SolarCity: great company, bad investment
SolarCity has a wonderful long-term business model. It installs solar systems on homes and businesses at no cost to owners, who sign a 20-year contract to pay for the electricity generated. SolarCity is growing like a weed on steroids, guiding for 70% CAGR customer growth through 2018.
How can I be opposed to such an investment? For two reasons: escalating costs and share dilution.
The US recently imposed steep tariffs on Chinese imported solar panels, which SolarCity was using for its systems.
In response SolarCity spent $200 million to purchase panel maker Silevo, which is working on panels with 24% cell efficiency that would reduce the amount of panels needed by 25% and greatly cut costs.
So what's the problem? SolarCity is guiding for 1,400 MW to 1,650 MW of installations through 2015 yet Silevo's manufacturing capabilities are just 32 MW annually.
With just $320 million in cash, a potential extra $150 million payment to Silevo and $734 million in expected losses through 2015, SolarCity likely won't be able to increase Silevo's production or achieve its growth goals without raising substantial amounts of additional capital. In fact, SolarCity has stated that it intends to invest $500 million into expanding Silevo's capacity to 1 GW within the next two years. With $710 million in current debt
my concern is that SolarCity will accelerate its share dilution rate in order to raise these sums. Given its already high valuation of 32 times sales, accelerating dilution will slow eventual earnings growth (once SolarCity is profitable) and act as a drag on long-term performance.
SunPower: profitable best of breed
SunPower is the best solar company investors can own for three reasons: its superior technology and its distributed generation business gives it a strong growth catalyst.
SunPower's has tested panels with pre-production cell efficiency of 25% and that are five times more reliable than its competitors' products, delivering 75% more power over a 25-year period.
SunPower is also leasing private solar power systems under long-term contracts. By 2015 it estimates it will have doubled its customer base to 300,000 and more than tripled its contracted cash flows relative to 2012.
Foolish bottom line
First Solar, SolarCity, and SunPower will all grow their businesses in the next decade. However, SunPower, with its superior technology, strong growth catalyst, and minimal dilution, is likely to result in the best long-term returns. SolarCity is an innovative company with a terrific business model and strong growth ahead of it, but massive shareholder dilution is likely to slow long-term share appreciation. Meanwhile, First Solar will continue to struggle to win contracts and grow sales unless it can greatly improve the efficiency of its panels to match its competitors.