Suntech Power Holdings (STP) is trading sharply higher this morning after the company announced that they would be opening a manufacturing facility in Arizona.  The China-based solar panel maker has managed to remain profitable this year despite a difficult environment for solar manufacturers.  The expansion move instilled investor confidence as positive news flow out of the solar sector has begun to spark buying.

Late last week, Yingli Green Energy (YGE) also saw its stock lift after announcing a positive quarter and raising estimates for the coming year.  Management cited an expected improvement in profit margins for 2010 which is a significant change in trend for the company and for the industry as a whole.

In 2007, solar manufacturers bucked the topping trend in the overall market by rallying sharply as demand for solar power began to expand.  Rising oil prices and potential shortages of traditional fossil fuel sources had investors anxious to own a piece of the coming solar power boom.  However, as financial markets collapsed, the entire world entered a significant recession, and traditional energy prices dropped; the allure of solar energy began to decline.

At the same time that demand was declining, advances in technology caused supply to increase exponentially.  The manufacturing process to create and use polysilicon became more cost effective and efficient, leading to an inventory glut and sharply lower end prices.  This caused many solar players who had used excessive leverage to increase manufacturing capacity to struggle.  With profit margins dropping and the cost of capital remaining stubbornly high, many players in the industry had to capitulate.  Stock prices sank, and investors quickly saw significant losses.

Today, the picture is once again beginning to change.  As stimulus programs are in place with a bent towards decreasing our dependence on foreign oil and increasing the portion of renewable energy used, the consumption of solar energy is on the rise.  There are still significant financial, political, and infrastructure issues to be resolved, but the picture is brightening for this industry.

Investors need to carefully weigh their positions in the solar industry because not all solar opportunities are created equal.  Some of the major pitfalls which should be considered include the debt levels of individual companies, long-term contracts with customers or suppliers, and the specific technology used in the manufacturing process.  Nearly every major player in the industry has significant debt.  What varies is the assets backing up that debt and the level of cash flow available to serve that debt.

Yingli has a published debt to equity ratio of 40% which is fairly attractive for the industry.  While the company is expected to post a loss of 22 cents per share this year, analysts expect the increased profit margins to yield 76 cents in profit next year which puts the stock at a multiple of 18 times next year’s earnings.  That multiple looks relatively attractive given the company’s increasing fundamental prospects and the traction we are seeing in the industry.

Suntech has a much higher debt load, listed at 92%, but should manage to post a small profit this year.  The company will need to arrange financing for its Arizona plant which may increase the risk for the company to a small extent.  However, the market appears more confident in STP’s ability to generate profit growth as the stock is trading at 27 times 2010 expectations.

The solar industry could offer significant gains for 2010 but volatility will likely be high.  Aggressive investors may choose to ride out the swings and look for long-term gains.  Another more conservative approach would be to buy positions in individual solar names and then sell calls against those positions.  The calls will cap total gains available to investors, but will also serve to generate a “synthetic dividend” offering cash flow and a reduction in risk.  The premium on these options are relatively attractive depending on which issue you are considering.  Risk control is still the most important consideration, but there remains some attractive opportunities in play.

FD: Author has a long YGE position in the ZachStocks Growth Model

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