Solar Stocks Looking a Little Brighter

Solar stocks surged higher yesterday, led by the company that once led the industry: First Solar (NAS: FSLR) . News that First Solar was delaying a plant closing helped push the stocks higher, but it was hope that demand from Germany and Italy would be higher than expected that kept them moving higher throughout the day.

Reading the tea leaves
First Solar first announced that it would close its Frankfurt, Germany, facility in April, causing the stock to go into a tailspin as investors fretted about the company's strategic position and overall solar demand. The news yesterday that higher-than-expected demand in Europe during the second quarter has caused the company to move the closing back by about six months has at least made investors pause for a moment.

The news shouldn't be a huge surprise to those following policy changes. Italy and Germany, the two biggest solar-demand sources in Europe, have both pushed back feed-in tariff cuts under pressure from the industry. Italy even announced a carbon tax that will be used to fund renewable energy production. Demand in Europe won't grow much, if at all, this year, but it isn't going to fall off a cliff the way some expected.

First Solar has always relied heavily on Europe, but it's players like Suntech Power (NYS: STP) , Yingli Green Energy (NYS: YGE) , and Trina Solar (NYS: TSL) that should be breathing the biggest sigh of relief today. These companies get a majority of their demand from Europe, and even though they've been trying to diversify, other locations of demand aren't quite ready to pick up the slack. What I would expect in the short term is steady demand of modules versus previous quarters, which should help top-tier companies, but it won't do much to save those that are treading water.

This doesn't save everyone
The market's reaction with low-tier stocks was overblown at best. LDK Solar jumped 17% yesterday, ReneSola (NYS: SOL) jumped 8%, and Hanwha SolarOne gained 4% on the market, but this won't be enough to save them. These companies have seen sales fall and gross margin go negative, and they need a lot more than just steady demand in Europe to have a bright future.

The delay of feed-in tariff reductions doesn't do anything to raise prices for these companies, which might by extension make them profitable; it will only keep demand elevated, and that demand will most likely go to top-tier suppliers.

A bridge to the future
The industry has been looking for a bridge to markets that are more sustainable over the long term. Those markets include India, China, Saudi Arabia, and the U.S., places where we're beginning to reach grid parity without subsidies. Solar has been given a footing in these locations and is growing, but it hasn't had nearly the base Germany and Italy have had, so overall demand of solar modules was expected to stay relatively flat this year. Even a slight boost in that forecast will help solar manufacturers at the top of the food chain.

I wouldn't expect this to change the overall picture for solar manufacturers, only put a bandage on short-term issues facing the industry. Efficiency will still need to improve, costs will need to come down, and low-tier players are going to have to exit the market for supply and demand to arrive at any sort of normalcy.

What to do now
As we've seen in the past, a short-term bridge to the future has opened just when the solar industry needs it. The impact will be positive for all manufacturers, but I would still stick with those who have industry-leading efficiency and margins if you're looking to buy solar stocks. SunPower is my top pick, with Trina Solar and Canadian Solar following as two top Chinese suppliers.

First Solar may indeed be a value play because of how far its stock has fallen, but I don't expect thin-film to be a leading technology unless efficiency improves dramatically.

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At the time thisarticle was published Fool contributorTravis Hoiumowns shares of SunPower in a personal and a managed account and has sold puts on SunPower shares. You can follow Travis on Twitter at@FlushDrawFool, check out hispersonal stock holdingsor follow his CAPS picks atTMFFlushDraw.Motley Fool newsletter serviceshave recommended buying shares of First Solar. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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