As the global solar industry has boomed in 2014, some of the largest Chinese solar manufacturers have continued to struggle on the stock market.
The big reason Chinese solar stocks aren't doing well is the fact that Chinese manufacturers haven't been able to swing to profitability despite a surge in demand for solar panels. Most companies are still losing money each quarter and even those that are making a profit, like Trina Solar (NYSE:TSL) and Canadian Solar (NASDAQ:CSIQ), are clinging near break-even.
So, why aren't Chinese solar companies profiting as demand for solar grows? A few big factors are getting in their way.
U.S. tariffs have hurt demand
This summer, the U.S. put punitive anti-dumping and anti-subsidy tariffs in place for Chinese solar manufacturers, which will make it hard for them to compete in the U.S. market. Tariffs will average 47.27% and even the lowest cost Chinese solar manufacturer can't compete with that additional cost.
SolarCity (NASDAQ:SCTY.DL) quickly moved to sign a supply agreement with REC Solar and then bought panel manufacturer Silevo to build its own solar modules. Utility and commercial scale projects that were planning on using Chinese panels have also been put into question because of the higher costs that tariffs will bring.
The U.S. isn't the only market in the world, but it's a key market that's expected to grow 36% to 6.5 GW this year, and it leaves a smaller pie for Chinese competitors to fight over in the rest of the world.
Technology is falling behind competitors
China took control of solar manufacturing between 2008 and 2012 because it was able to lower costs faster than competitors. Costs of standardized equipment dropped rapidly and oversupply of polysilicon helped drive costs even lower.
But panel costs are no longer the main driver of solar installation costs because the panel only accounts for about a quarter of the system's cost. Instead, companies are trying to squeeze more efficiency out of each square inch, because increased efficiency doesn't increase balance of system (non-panel) costs but it increases the amount of energy produced by a system.
When it comes to technology, China is making commodity panels that are becoming less competitive versus companies like SunPower (NASDAQ:SPWR), Kyocera, Sharp, and others who make panels that are more efficient. They may cost more per watt, but the cost savings in other parts of the system make the added panel cost worthwhile.
Essentially, China is still competing on costs when it comes to selling panels where higher efficiency panel makers are able to charge more per watt and still stay competitive. The result is lower margins for Chinese companies than higher efficiency competitors.
Foolish bottom line
If the solar market continues to grow there could be a positive impact on Chinese solar manufacturers like a tide that lifts all boats, but this impact could be short lived. Manufacturers are already building out next generation equipment that could bring cell efficiency to well over 20%, something China can't compete with today.
The choice then becomes lowering costs on existing technology or upgrading to keep up with competitors. If Chinese manufacturers can't make a profit today they'll have a tough decision to make when it comes to next generation equipment. Investors should instead focus on companies making money in today's market that have a technology advantage over commodity manufacturers. That'll be a more durable advantage long-term, something we're already seeing play out in the market.
Travis Hoium manages an account that owns shares of SunPower and personally owns shares and is long SunPower options. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.