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Investors, traders, and the general public have taken a rather negative view of the solar industry in recent months and it shows; the sector has been pummeled, down nearly 60% year to date. Even as the stock market rallied through the first half of the year, most solar stocks dropped. The failure of Solyndra and the subsequent investigation of the company’s offices by the FBI in recent months, certainly has not helped reverse investor sentiment about solar stocks. However, it’s important for investors to examine the fundamentals behind individual stocks, rather than listen to all the noise and jump to conclusions. The questions to consider are whether or not the precipitous selloff in solar is justified and which stocks, if any, could be poised for a rebound when the smoke clears. Here we examine these issues and look at some potential recovery candidates.

So, why the negative outlook? Well, a large point of concern and the consensus view seems to be that solar companies cannot survive without heavy government subsidies, because they are not currently competitive with traditional fossil fuel sources. At this time, the industry depends on loan guarantees from the Department of Energy to meet its funding requirements and to remain competitive. Indeed, solar power has not yet achieved parity with other sources of power generation and will probably require subsidization for some time. Solyndra’s failure could spell the end of such programs or at the very least, lead to a major curtailment in funding.

On the other hand, it is possible that solar companies will be able to stand on their own, without government support in the not-too-distant future. The inputs required in making solar panels, which consist primarily of polysilicon, now cost a fraction of what they used to just a few short years ago and, as a result, solar panels are considerably more affordable today. With fierce competition entering this already-crowded market, the price of raw materials and solar panels should continue to decline over the next several years. If this trend continues, solar energy should become more cost-competitive with electric power and become a more profitable endeavor.

With changing price dynamics, there is huge growth potential in this very young market. Just looking at solar from a global energy perspective reveals the true scope of expansion possibilities. Europe and Asia are investing heavily in solar power, thanks to government mandates that require new energy standards to be in place by specific dates, so there is no shortage of demand here.

Increased global demand for oil should continue to spur interest in alternative energy sources, which may not keep their “alternative” moniker for long if current trends progress at the alarming pace of recent years. But, the relatively low price of crude oil this year, at least in comparision to the pre-recession highs, has kept these concerns at bay. Worries of recession and economic instability around the world have pushed crude prices somewhat lower at times. Solar stocks almost invariably maintain an inverse relationship with crude prices, since the two essentially compete against each other in the global market place. However, as the global supply of oil dwindles down, prices could climb back into the triple digits.

The long-term case for solar is fairly strong, in our opinion, but picking potential stock candidates within the sector can be problematic. Companies like Rene Sola (SOL) and LDK Solar (LDK) have seen their sales explode in recent years, yet their shares trade at or under $4 as of this writing, down from about $15 and $13, respectively around this same time last year. The price declines seem overdone, and valuations are turning more compelling, even when considering the potential risks involved. It is difficult to pin a price-to-earnings multiple on a company like LDK Solar, since analysts already have revised their earnings estimates downward several times and visibility remains low.

It appears most solar stocks are currently priced as if the underlying companies are planning to encounter years of frustration, which probably isn’t far from reality. Like many newer processes at the start of the 21th Century, there are always many startups in the beginning, but eventually the industry consolidates and only the stronger players survive. The key to solar’s success is mass production. Just as Henry Ford found a way to produce automobiles cheaply in mass quantities, some companies will find a way to build solar panels profitably; it’s just a matter of time.

 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.