One of the craziest things happening in the energy sector right now is the drop in solar stocks. The industry is booming as everyone from homeowners to corporations look for ways to save money and generate more of their own energy.
But over the past year, solar stocks have dropped along with oil prices and a general sell-off in energy stocks, including industry leaders SunPower (NASDAQ:SPWR) and First Solar (NASDAQ:FSLR). For long-term investors, there are reasons to think these two stocks in particular are set for a strong recovery in the next few years.
Catalysts coming to the solar industry
Solar stocks have been hit by a general decline in energy stocks, but that decline could be temporary in nature. Some market forces keeping investors out of solar may turn around in the next couple of years.
Low oil prices have hurt solar stocks despite the fact that solar energy rarely competes head to head with energy from oil. But it's unlikely oil will remain below $50 forever. U.S. shale producers are already cutting production, and dozens of companies could go out of business over the next year if oil stays below $50 per barrel. That could further reduce supply, and booming SUV sales will help demand. Even a slow rise in oil to $60 or $70 per barrel could help solar stocks, even if the impact is only psychological.
Solar doesn't directly compete with oil, but it does compete with natural gas in the electricity market. So, the pending exports of U.S. natural gas from newly completed export facilities later this year could have a big impact on natural gas prices. Cheniere Energy will begin operating its LNG terminal in December, and it plans on being the largest single buyer of natural gas in the U.S., which it will then sell to customers overseas once both of its facilities are up and running. With natural gas prices near a decade low, that could mean a big rise in natural gas prices, which would help solar companies sell energy to utilities.
The biggest catalyst to watch for may be in Washington, D.C. The solar industry has long relied on a 30% investment tax credit to subsidize solar installations, but in 2017, that subsidy will fall to 10% for commercial systems, and be eliminated for systems owned by homeowners. That could cost the country 80,000 jobs almost overnight, according to the Solar Energy Industries Association, and with support for solar around the country and across the aisle, it's likely that some sort of extension or replacement will make its way through Congress in the next 15 months. When it does, investors will see more certainty in solar stocks.
These are catalysts that could boost the entire solar industry, and I think all three are only a matter of time. But where should you put your money?
Why SunPower and First Solar are where investors want to be
As the solar industry benefits from these catalysts, where do investors want to be? I think the answer is with the leading technology companies in the industry.
SunPower makes the most efficient solar panels in the industry and has turned that into the most diverse business in solar. The company builds everything from the smallest solar systems, a 1 watt portable charger, to the largest system in the world, the 579 MW Solar Star project. The company's business model provides the diversity needed to survive in solar long term, but it also provides a competitive advantage over competitors. With shares trading at 13.5 times next year's earnings, and management expecting to triple production over the next five years, I think there's huge upside in this stock.
The greatest comeback story in solar belongs to First Solar, who, over the past decade has gone from the industry's leader to being surpassed by commodity solar panel manufacturers in China to a leader again. Like SunPower, the improvement comes down to technology. A vast improvement in panel efficiency in the past year has driven the company's improved competitive position, and management expects efficiency to improve to near 20% over the next five years, compared to 14% to 16% for the typical commodity panel. When combined with the company's expertise building large solar systems, that puts First Solar in a strong position. And shares trade at just 12.3 time next year's estimates, so there's upside here as well.
A solar boom is happening now
There've been a lot of ebbs and flows in the solar industry over the past decade, and that may make investors uneasy. But the reality is, the solar industry is now in a position to compete against fossil fuels on a cost basis, and by the looks of it, the cost of fossil fuels may be due to rise significantly.
With that backdrop in mind, the technological differentiation and industry experience SunPower and First Solar bring to the table are where investors should be looking. I think these two stocks will be big winners over the next decade and could be dominant players in the future of energy.
Travis Hoium owns shares of First Solar and SunPower. The Motley Fool has no position in any of the stocks mentioned. 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.