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Why First Solar and SunPower Are Winning in Solar

By Travis Hoium - Feb 9, 2016 at 9:00AM

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The focus on strong balance sheets and utility scale projects has helped two of the industry's largest companies.

Large solar projects like this one are leading to superior performance for solar companies. Image: SunPower.

Over the past six months there's been a divergence in the performance of solar stocks. Where high growth was once praised despite losses quarter after quarter, investors are now valuing companies that can prove consistent profitability. First Solar (FSLR 0.68%) has been by far the best performer in this new paradigm, whereas SunPower (SPWR -0.74%), and SolarCity (SCTY.DL), have lagged behind - something that would have been unthinkable a year ago. But it's why First Solar, and to a lesser extent SunPower, are outperforming higher profile competitors that should have investors' attention:

SCTY Chart

SCTY data by YCharts

Residential solar is more competitive than we thought
The big revelation after third quarter 2015 earnings were released was that residential solar was not the natural growth market it was made out to be. SolarCity spent 60% more per watt to acquire customers in Q3 2015 than they did in Q3 2013 ($0.64 to $0.40), a trend that could be seen in all residential solar installers.

This cost increase shows just how competitive the residential solar landscape has become and how little automation there really is. Instead of demand being pulled from customers it's being pushed by door-to-door salesmen and people at booths in retail stores. That may not be a path to sustainable growth and it's hardly the industry's biggest problem.

Nevada brought up residential solar's biggest nightmare
The dirty little secret of residential solar companies is that they're beholden to regulators to put policies in place that make rooftop solar economical. The main policy they need is net metering, which compensates solar electricity exported from a home to the grid at the customer's retail rate.

In December, Nevada upended net metering and decided the utility only needed to pay the wholesale rate for electricity, or a drop of about 9 cents to 2.6 cents per kWh. On top of that, fixed fees are going to jump from $12.75 per month to $38.51, another hit to the economics of rooftop solar.  

The result was every major residential solar installer fleeing the No. 2 rooftop solar state within days of regulators' ruling. Utility scale solar, where the utility is the buyer of electricity and regulators essentially put their stamp of approval on projects, is much more stable than rooftop solar, something investors are finding out the hard way.

Utility scale solar is the big winner in the ITC extension
The reliability of larger scale solar projects would be enough for First Solar and SunPower to outperform SolarCity recently, but they'll also likely be the biggest beneficiaries of the ITC extension. Residential solar installers would have had to adapt to the new subsidy structure, but the industry wasn't predicting a massive drop-off in demand if the ITC had declined as planned in 2017. But utility scale solar would have been crushed.

Image: GTM Research.

You can see in the chart above that GTM Research was predicting nearly a 90% decline in utility scale solar installations between 2016 and 2017 because of the ITC decline. That's because utility scale projects are generally lower margin and are much more sensitive to cost fluctuations as they compete with fossil fuels for energy contracts.

With the ITC extension in place First Solar and SunPower, who are the two largest utility scale project builders in the U.S., will be able to grow even more quickly than they had planned. The real windfall of the ITC falls on large-scale projects and the market is finally pricing that into these stocks.

The competitive landscape matters
As the solar industry grows the rules of the game will change, particularly in residential solar. Companies in the best competitive position will be able to adapt and profit from those changes. You can see below that First Solar and SunPower have also translated their competitive position into profits, something SolarCity hasn't been able to do yet. 

SCTY Net Income (TTM) Chart

SCTY Net Income (TTM) data by YCharts

Right now, the changes in solar are favoring utility scale projects and companies with rock solid balance sheets. That plays right into the hands of First Solar and SunPower and it's why they've outperformed SolarCity in the past six months. And with new net metering rules being rolled out around the country I would expect the outperformance of utility scale project builders to continue throughout 2016.

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Stocks Mentioned

First Solar, Inc. Stock Quote
First Solar, Inc.
FSLR
$70.07 (0.68%) $0.47
SunPower Corporation Stock Quote
SunPower Corporation
SPWR
$17.36 (-0.74%) $0.13
SolarCity Corporation Stock Quote
SolarCity Corporation
SCTY.DL

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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