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First Solar, Inc. (FSLR), SolarCity Corp (SCTY): The Best Way to Handle Solar’s Transition

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Solar energy is in a transition.

Panels are achieving parity with grid energy in more-and-more places. The maps put out by groups like the Institute for Local Self-Reliance as recently as this year may be partly obsolete, as installed costs for panels are now far below the $3.72 per watt being quoted as the 2013 average.

Prices for Chinese polysilicon panels, roughly 50 cents per watt, on par with grid power are now expected to fall to as low as 36 cents per watt in four years. And past performance has exceeded these kinds of estimates.

First Solar, Inc. (NASDAQ:FSLR)

In response, the two main “green energy” ETFs, the Claymore/MAC Global Solar Index and the Market Vectors Solar ETF (KWT) have both been rising. KWT is up 22% over the last three months, TAN is up almost 36%.

In the past these have been the best way to play the sector. Are they still?

What grid parity means

Grid parity is an important concept for solar investors. It means that you can put up a solar panel and deliver power for the same price as the power grid can.

It’s a tipping point. Before grid parity you need various forms of subsidies, like Feed-in Tariffs (FiTs) and Renewable Energy Credits (RECs) in order to make a deal work. The Feed-in Tariffs are direct subsidies. The RECs are used by power buyers to make their operations appear “green.”

Once you pass grid parity, these tools are no longer necessary. Government aid to the sector can be safely removed, and the sector will continue to improve. Demand feeds on itself. The only case for government aid, in fact, becomes a protectionist one – you want your nation to have a piece of the growing market? Then make sure your prices are competitive.

Another thing happens when you reach grid parity. The margins within the channel come under pressure. When prices are higher than those for grid energy, then anyone who can talk people into buying solar power is very valuable. Afterward, you can stock panels in a big store and get a crowd. This is what happened with computers in the 1970s – margins were compressed as the business moved from Value-Added Resellers to computer stores.

The whole vs. the niche

TAN and KWT invest in the whole sector. Both suffered in 2012 because they were very heavily invested in panel producers, especially those based in China. The bigger gains, meanwhile, went to those companies that could create a channel for panels. The market’s recovery began with companies like First Solar, Inc. (NASDAQ:FSLR), which began building utility-size projects which were sold to power companies, and to SolarCity Corp (NASDAQ:SCTY), which were selling and financing rooftop systems to consumers.

Those companies are now near the end of that run. SolarCity Corp (NASDAQ:SCTY) is especially illustrative. The stock peaked in May at over $50 per share, but now stands below $35 per share, a 30% drop. Sales remained strong, and were 20% higher in the first quarter of 2013 than the same quarter a year ago. But net income, which seemed headed into the black, turned sharply lower – the company lost $39 million in the March quarter.

First Solar, Inc. (NASDAQ:FSLR) has been partly protected from that change, because they make panels, they don’t just sell them. The company remained profitable in the first quarter, with sales 60% higher than in the same quarter a year ago. But solar does not have the same sales pattern as other technologies, and the 30% drop in revenue from the December quarter had to be worrying to investors.

While SolarCity Corp (NASDAQ:SCTY) has been the best place to play since the start of the year, the more recent action has told a different story. The indexes have been far stronger than the individual players, with SolarCity Corp (NASDAQ:SCTY) accelerating to the downside over the last month, and both the indexes showing strong gains over the last three. First Solar, Inc. (NASDAQ:FSLR), meanwhile, has done even better than the funds, scoring a 42% gain for shareholders in the last three months.

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