Solar companies poised to make hay while the sun shines

Select solar companies that got in the game at an early stage have a first-mover advantage, are attracting more investment than their conventional counterparts, and are poised for long-term growth both at home and away, according to Morningstar equity research.

A leading clean energy company in the United States,  SolarCity (SCTY) produces, installs and services residential solar systems. The company also offers solar products to commercial and industrial customers predominantly in the U.S. Northeast and Southwest.

"SolarCity should benefit from the continued expansion of solar generation adoption," said Morningstar equity analyst Andrew Bischof in a report. "Its 34% residential market share is greater than its next 70 competitors combined."

The solar supplier is widely expected to benefit from its association with Tesla and its ambitious electric car and battery project. Electric carmaker Tesla's CEO Elon Musk is also the chairman of SolarCity, which was founded by his cousins Lyndon and Peter Rive.

Notably, SolarCity will purchase the bulk of battery packs from Tesla for a residential project, called Smart Energy Home, in the state of Hawaii, which is committed to the goal of 100% renewable energy by 2045. Further, the Kauai Island Utility Cooperative (KIUC) singed a power purchase agreement with SolarCity wherein the latter will supply utility-scale energy storage systems that can feed the state utility grid for use during peak demand hours.

The project's success could lead to its implementation in other jurisdictions and lucrative purchase agreements with other state utilities.

"SolarCity currently operates predominantly in the Southwest and Northeast, but adoption can spread beyond those regions as market awareness increases and public policy continues to support renewable energy," said Bischof, who pegged the stock's worth at US$20. "Solar adoption will continue to gain market share as costs for solar adoption decline and customers' utilities rates go up."

He warns, however, that despite strong growth prospects, management needs to navigate through challenges such as access to cheap capital, low barriers to entry and a potentially intense price competition.

 First Solar (FSLR) makes electricity-producing solar modules and constructs turnkey solar systems.

"First Solar truly has the brightest future of any company in the sector," said Morningstar sector director Stephen Simko in a report. "Its technology road map and cost-reduction plans are enough to ensure that the company will remain solidly profitable beyond the next couple years."

Although Simko expressed concerns over potential cost pressure from Chinese competitors "making the company's stock a risky play," he added that any "bearish assessment of First Solar's business understates its longer-term competitive position."

The company's unique thin-film technology, he said, offers greater scope to reduce costs relative to low-cost Chinese competitors during the next few years. "First Solar has the most defensible positions of all solar module manufacturers, given its competitive cost structure and strong balance sheet," said Simko, who appraised the stock's worth at US$62.

He projected 2019 earnings before interest, taxes, depreciation and amortization (EBITDA) of US$625 million while asserting that the firm will be the "industry's cost leader in the second half of the decade and thus the industry's most profitable company."

Following its first-quarter revenue miss, the stock fell about 16%, which could well be a buying opportunity considering the solar panel maker raised its 2016 earnings per share target to US$4.30 from US$4.25 and operating cash flow estimate to US$600 million from US$500 million.

One of the world's largest manufacturers of solar modules,  Trina Solar (TSL) also makes other solar-power products such as photovoltaic wafers. The company also builds turnkey solar power generation plants in China and sells them to third parties.

"Of all of the low-cost Chinese solar companies, Trina has some of the brightest prospects," Simko said in a Morningstar report. "With production costs now approaching US$0.50 per watt, its cost structure is currently near the forefront of solar."

The company boasts a strong balance sheet compared to its peers. "In terms of operational competitiveness and balance sheet strength, Trina stands out as a clear winner in upstream solar," said Simko. Another area where the firm defies industry norm is its operational decisions, where management "seems to at least consider shareholder value," he added.

One of the better allocators of capital in the solar sector, the firm has also stayed ahead of its competition in terms of anticipating industry trends, said Simko, citing management's move to rein in wafer capital expenditures and production before wafer prices slumped.

However, he stressed the need for cost reduction to go beyond what's achieved through supply chain optimization and falling silicon prices, and to focus on lowering cost through production and technology improvements.

Companies like Trina are well positioned to benefit, as China will be one of the largest contributors to the growth of global market, driven by "ongoing cost reduction of solar," according to a report by HIS Inc.

Simko recently raised the stock's fair value to US$10.50 per American depositary receipt (ADR) from US$8 and forecasted the company will generate mid-cycle gross margins in the 10% to 15% range.

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