Five Stocks That Will Thrive After the Solar Energy Industry Shakeout

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With as much as two-thirds of the struggling solar energy industry expected to either fail or be acquired over the next three years, the table will be set for the survivors to capitalize on a market with enormous growth potential.

The process has already begun, with three solar companies - Evergreen Solar Inc. (Nasdaq: ESLR), Spectra Watt Inc. and the notorious Solyndra LLC - having declared bankruptcy this year.

Solar companies have struggled to keep their heads above water as the price for solar panels has fallen as much as 40%. The average operating margin in the solar energy industry plummeted to 0.1% in the third quarter from 13.7% a year earlier.

The stocks have been pummeled, as a result. The Claymore/MAC Global Solar Index (NYSEARCA: TAN) exchange-traded fund (ETF) is down 58% this year and the Market Vectors Solar Energy (NYSEARCA: KWT) ETF is down more than 60%. Several individual solar stocks have lost more than 70%.

"It's just a really difficult time," Morningstar Inc. (NYSE: MORN) alternative energy analyst Stephen Simko told The Globe and Mail. "The profitability of the industry has collapsed... Unless more bankruptcies happen and more production is shut down, this is a problem that is going to persist."

Few Will Be Left Standing

The tremendous pressure on margins has most people both outside and inside the solar energy industry predicting massive consolidation.

"This is the decade of mergers and acquisitions," Jifan Gao, chief executive officer of Changzhou, China-based Trina Solar Limited (NYSE ADR: TSL), told Bloomberg News. "From now until 2015 is the first phase, when about two-thirds of the players will be shaken out."

The Macquarie Group Limited (PINK ADR: MQBKY) agrees. In a recent report the Australia-based research firm said consolidation would claim 66% of the world's solar companies. Macquarie predicts that only four out of 35 solar companies in China will survive the next three years.

But in the aftermath of the carnage, the surviving solar companies will emerge stronger and in prime position to make the most of an exploding market.

In fact, the solar market has grown in 2011, but because capacity has exceeded demand, prices have continued to fall.

A Growing Market

According to the Solar Energy Industries Association, solar is the fastest-growing energy sector in the United States. The group says solar panel installations in June were up 69% over the previous year.

That pace of growth is expected to continue for an industry that supplies just 1% of the electricity in the United States. The U.S. Energy Information Agency projects installed solar energy capacity to increase 20 to 40 times 2010 levels over the next decade.

The primary reason for such optimism is the same reason the industry is suffering - falling prices that make solar competitive with traditional sources of energy like coal, oil, and gas.

First Solar Inc. (Nasdaq: FSLR), for example, says the solar panels it makes now can produce electricity for 14 cents to 16 cents per kilowatt - still significantly above the average cost of electricity in the United States of 11.6 cents per kilowatt.

But the solar energy industry has steadily improved panel efficiency, and expects the advances to continue. First Solar says that by 2014 its panels will produce electricity for 10 cents to 12 cents per kilowatt.

"At that point, there's a tremendous amount of interest," First Solar spokesman Alan Bernheimer told USA Today.

But which companies will survive to reap the benefits of the golden days of solar?

Five Solar Survivors

The survivors in the solar energy industry will be those companies that can ramp up economies of scale and that have the strongest balance sheets. Even so, the volatility within the industry means elevated risk for just about every stock. On the other hand, the severely depressed stock prices now mean dizzying upsides for the winners.

Here are the five best prospects:

  • Suntech Power Holdings Co. Ltd (NYSE: ADR STP): Suntech is the world's largest maker of solar panels and, as a Chinese company, will continue to enjoy government subsidies for the foreseeable future. As more solar companies get into trouble, an increasing portion of the business has gravitated to the largest like Suntech. The company expects its gross margins to rise from 11% to 13% this quarter. Because the stock is down 67% for the year, its price/earnings (P/E) ratio is just 2.95. The one risk for Suntech is its $2.47 billion in combined short- and long-term debt.
  • First Solar: This Arizona-based company has one of the highest gross margins in the solar energy industry - 42.6%. First Solar also has a promising thin-film technology that should make it a leader in efficiency. It also has one of the strongest balance sheets, with more cash than debt. The stock is down 65.5% year-to-date, dropping its P/E to 7.37.
  • Trina Solar Limited (NYSE ADR: TSL): Trina is the world's fifth-largest solar panel maker, and also benefits from being based in China. The company has 17% margins and nearly as much cash as debt, though it can count on government subsidies in a pinch. Its stock is down 71% this year, giving it a P/E of only 1.80.
  • Yingli Green Energy Holding Co. Ltd. (NYSE ADR: YGE): Yet another Chinese company, Yingli has the size and scale to survive as well as a better-than-average balance sheet with $1.1 billion in cash. Yingli is down 67% for the year, which has put its P/E at 2.09.
  • SunPower Corp. (Nasdaq: SPWRA): California-based SunPower recently announced a new technology, C7 Tracker, that it says will allow its panels to produce electricity 20% cheaper than those of rivals. In addition, SunPower has a utility plant division, which means it can sell panels to itself. But its biggest advantage is a $1 billion line of credit from energy giant Total SA (NYSE ADR: TOT), which also owns 66% of the company. It does have shaky financials, however - it's carrying $820 million in debt, $20 million more than its market capitalization. The stock is down 43.41% this year, and its P/E is 3.0.
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