Want to gauge a solar company's survival chances? Look at its financial strength. That, more than any technology or manufacturing edge, will determine which companies are still standing in 2015.
That's because 2011 and 2012 look grim. The world saw 23 gigawatts of new capacity installed in 2010, according to SMA Solar Technology. (As the leader in the photovoltaic inverter market, SMA has a good take on industry trends.) In 2011, additions will total just 19 gigawatts to 21 gigawatts. The company says 2012 will see modest, if any, growth from 2011 levels.
Those projections make sense if you consider that some of the countries with the most generous subsidies for solar power -- Italy, Germany and Spain -- are at the center of the euro debt crisis and the slowdown in European economic growth.
Now, this drop in the growth of solar capacity wouldn't be too bad except that the industry has so much new manufacturing capacity coming on line. With demand dropping and capacity growing, we're looking at a price squeeze in the fourth quarter of 2011 and in 2012 that will make the hair-thin average operating margins in the third quarter look like the good old days. If half of the solar companies were running operations in the red in the third quarter, imagine the bloodbath this quarter. And in quarter after quarter in 2012.
The damage won't be spread evenly around the industry, either. Already, we're seeing sales flow toward the biggest players in the industry -- those that customers can count on to be there even if times get tougher. Nobody wants to plan a solar project and then have suppliers go bust. For instance, the top six manufacturers of solar panels took 55% of the market in the second quarter of 2011, according to China's Suntech Power (STP -0.36%, news). That was up from 26% in 2010.
Look to the stars
In this environment, I'd have to have a really, really good reason to invest in any company outside the top 10 in its sector. Or any company that was highly leveraged. My preference would be for companies with big market shares and deep pockets.
So I'd cast a dubious eye on companies like China's LDK Solar (LDK +3.99%, news), the world's second-largest maker of silicon wafers used in solar panels, and Canadian Solar (CSIQ -2.49%, news), a maker of solar panels, that show twice as much short- and long-term debt as shareholder equity, according to Bloomberg.
But I go beyond balance sheets in my due diligence to look at whether a company has a way to tap deep pockets in order to survive. An example of what can happen even to the biggest of solar players is the fate of Conergy (CEYHF 0.00%, news), once Germany's largest manufacturer and installer of solar panels, which was taken over by its creditors in July.
Solar companies with deep pockets behind them include SunPower (SPWRA 0.00%, news), in which French oil company Total (TOT +1.79%, news) acquired a 60% stake in June; Hemlock Semiconductor, the world's biggest maker of polysilicon, which is owned by Dow Corning, which in turn is owned by Dow Chemical (DOW +2.34%, news) and Corning (GLW +3.71%, news); Japan's Shin-Etsu Handotai and Mitsubishi Materials (MIMTF 0.00%, news); and Chinese players such as Suntech Power, and Trina Solar.
Individually, these companies have the scale that I think you want to own in this sector. Suntech is the world's largest maker of solar panels by manufacturing capacity, for example, according to EnergyTrend. Trina Solar is No. 3, and Yingli Green Energy is No. 4.
And collectively China has the world's deepest pockets. The country has flagged solar energy as a key engine of economic growth for the next decade and has committed government funds to make that happen.
Still, we don't know which Chinese companies will get the government's backing through this shakeout.
Why it pays to wait
Here's where a strategy of waiting for 18 or 24 months or more pays an extra dividend.
Right now it's very hard to tell which of China's sector leaders will come through the shakeout in the best shape and which ones might be cut loose by Beijing.
For example, Suntech Power on Nov. 9 announced that it expects shipments in the third quarter to grow by 15% from the second quarter and for gross margins to climb 13% from an earlier forecast of 11%. That's great performance when the company's Chinese competitors have cut forecasts for shipment volumes and margins. But just about no one on Wall Street expects that the company can find a way to cut costs and expenses fast enough to escape the global downturn.
I'd sure like to see what the numbers look like in an quarter or two. And with trends going in the direction they are, I don't feel any great need to rush into action before I've seen what those quarters look like.
But building a post-solar-winter portfolio isn't just about deep pockets and market share. This is, after all, still a very new and fast-developing technology, and I think it's worth adding a few of the companies that are pushing the technology and manufacturing envelopes in the sector even if they don't have as much market share or deep pockets as the companies above do. If I had to pick companies that fit this description to add to this solar portfolio now, I'd pick First Solar (FSLR +1.17%, news), a leader in thin-film technologies that show the promise of beating the costs of silicon-based solar cells in the long run, and SunPower Technology, which is pushing the sunlight-into-electricity efficiency barrier as fast as anyone in the sector.
So if I were to pick a solar portfolio now I'd pick five stocks: Suntech Power, Yingli Green Energy, Trina, First Solar and SunPower.
