When former Vice President Joe Biden cinched the Democratic nomination back in August, investors in solar companies like First Solar (NASDAQ:FSLR) cheered. First Solar stock rose 34% as investors eagerly anticipated increased demand for the company, which is the largest U.S. producer of thin-film solar modules.
But don’t jump in just yet. Solar-panel manufacturing is a terrible business. Years of indiscriminate price-dumping by Chinese and Taiwanese makers have earned the industry the nickname the “solar coaster.” That means, for companies like First Solar to reach consistent profitability, Biden’s administration must push through workable solar tariffs. That’s something neither of his two predecessors could do.
Succeed with tariff reform, and First Solar stock will soar. More cynical investors, however, should focus on companies like SolarEdge (NASDAQ:SEDG), which avoids foreign competition by creating specialized solar technology. On Monday, worse-than-expected revenues pushed the stock down 20%, opening at $213 on Tuesday and continuing to fall. Near the close on Wednesday, it had dropped to about $204 … creating a golden opportunity to get in. Here’s why.
FSLR Stock: Riding the Solar Coaster
Despite top-notch R&D capabilities, First Solar has never reached consistent profitability. Net margins have gyrated between -14% to +14% as waves of cheap foreign solar panels have flooded the market.
Where did the cheap imports originate? The G.W. Solar Institute estimates that between 2010 and 2012, the Chinese government poured $42 billion into its solar industry. By 2014, the World Trade Organization (WTO) found that Chinese dumping rates ranged from 26.1% to 165%.
“China have [sic] been selling solar panels for less than their manufacturing costs,” reported G.W. Solar, “in order to make the products of American panel manufacturers uncompetitive and drive them out of business.”
A survey by Wood Mackenzie Research counted no fewer than 38 solar bankruptcies in 2012 alone. And although First Solar has survived thanks to its emphasis on research and development, its stock has still underperformed. Shares are up just 34% in the past five years, compared to the S&P’s 66% rise.
A Biden Presidency: Will Things Change?
It’s unclear how Biden’s climate change plan will benefit U.S. solar panel producers.
The U.S. government currently uses Section 201 and 301 tariffs to keep price-dumped solar panels out of the country. But these taxes are a blunt tool that targets both price-dumpers and unsubsidized low-cost manufacturers. That means that even though U.S. consumers pay 45% more than Europe and Australia for solar panels, American solar producers still can’t make money — they too are blocked from manufacturing in the cheapest locations.
Even if Biden’s climate change plan shores up solar demand, success will prove short-lived. First Solar’s low-cost competitors will eventually ramp up production to meet demand.
SEDG Stock: A Better Choice
To capitalize on increased solar demand, investors should instead turn to SolarEdge, a company with half the sales of FSLR but similar operating income (thanks to higher profitability). The company produces D.C. inverters that convert photovoltaic (P.V.) power into usable energy. They also offer cloud-based monitoring, energy storage and grid services.
It’s hard to overstate the difference the industry makes. Because SolarEdge doesn’t directly compete against price-dumped solar panels, profits at the company are very high. Since its initial public offering in 2015, SEDG has averaged a 36% return on invested capital (ROIC). Struggling First Solar, on the other hand, earned just 6% in the same period.
As I always tell investors: pairing 1) high ROIC companies in a 2) growing market with 3) reasonable valuations results in phenomenal investment returns. In the past five years, SolarEdge has returned 1,350% to investors. $5,000 invested in the company would be worth $72,500 today (versus just $7,750 for FSLR).
And SolarEdge still has room to grow. That’s because Biden’s climate change program promises to unleash investment in solar energy — regardless of whether utilities choose to buy cheap foreign panels or more expensive, locally made ones, SEDG will keep profiting.
What Are FSLR Stock and SEDG Stock Worth?
Biden might still implement legislation that saves the U.S. solar panel industry. That long-shot bet would make First Solar a clear winner: according to a two-stage discounted cash flow (DCF) model, 15% growth through 2024 and EBITDA margins moving from 13% to 23% would make FSLR worth $130, a 50% upside.
In the more realistic case, a combination of tax breaks and energy subsidies would increase demand but leave the broken supply of FSLR’s market in place. So, even though top-line growth would reach 12%, according to analyst estimates, that would still leave company shares worth $50 in the long run, a -37% downside.
SolarEdge, on the other hand, likely has a 70% to 170% upside if Biden’s climate change plans go through. If income grows to $7.6 billion by 2029 (a distinct possibility), and its EBITDA margins widen to 25%, SEDG stock will have a great deal of upside. Its surprising Q3 revenue miss of $338.1 million (vs. $342.6 expected) was still a sequential improvement from Q2 figures. (All solar numbers are coming off a major 2019 tax incentive). That makes SEDG’s 20% share price drop a good entry point for would-be investors.
In a sense, this is a classic case of buying a mining company versus investing in one that assembles mining picks. If you’re the only mining pick maker in town, there’s no reason to start mining too.
What Should Investors Do?
Of course, an investment in SEDG still won’t guarantee success. Its shares trade at 26x forward EV-to-EBITDA, a relatively high multiple for a manufacturer. And foreign competition could turn their attention to producing cheaper versions of SolarEdge’s flagship products. But investment trends only come once a decade or so. And the move from fossil fuels to solar energy is one that investors need to watch: according to the Energy Information Administration (EIA), renewables will overtake natural gas usage by 2042, with solar making up almost half the amount.
And that makes SolarEdge a better investment than First Solar. While FSLR stock could jump in the near term given its relatively high operating leverage, SEDG works in the far less competitive world of power optimizers and solar inverters.
Investors know that solar energy is coming. Might as well pick the winners.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
