One Simple Reason to Buy American Solar

Solar manufactures are struggling with commoditization. U.S. manufactures have been fighting to stay alive and compete with low-cost Chinese panels subsidized by Beijing. Going forward one major factor that will help U.S. manufacturers beat their competitors is R&D spending. Even with access to cheap capital, Chinese manufactures have consistently spent less than their U.S. competitors on R&D, thus stunting their long-term growth possibilities.

Annual R&D Spending

(All numbers in millions of $)

R&D spending counts
Goldman Sachs recently looked at the correlation between R&D spending and stock returns, and the company found a very strong link. It focused on large companies in the tech, biotech, and Internet industries, and Goldman Sacks' findings are relevant for technologically advancing industries like solar manufacturing.

The U.S. players
SunPower proudly announces that its R&D spending has allowed it to create panels that are very efficient and degrade slower than other panels. Based on studies in late 2012 and early 2013, the company estimates that with its X-Series panels customers can gain up to 75% more energy per square foot over the first 25 years of use compared to their competitors' panels. With continued investments in R&D, the company hopes to boost its X-Series' efficiency to 23% by 2015.

SunPower's investment in high-efficiency technology is paying off. Between the first and second quarter of 2013 it was able to decrease inventories by $46 million and post positive net income, thanks to strong global sales growth. SunPower's long-term future is also looking bright. As of May 2013 it had a 3.1 gigawatt pipeline in the Americas and a 1.5 gigawatt pipeline in the Middle East and Africa.

Solar panels face a trade-off between cost and efficiency. In the past First Solar tried to gain market share by offering low-cost products, but Beijing's decision to create a plethora of Chinese manufacturers financed by cheap state capital put First Solar on the defensive. For First Solar to step up its game and offer products that are more competitive on the basis of total system cost, it has been heavily investing in R&D. It just signed a special partnership with General Electric specifically to improve efficiencies.

It will take time for First Solar to bring its latest R&D advances to its products, but over the next couple years its partnership with GE should improve the company's bottom line. In the long run SunPower's high-efficiency panels will continue to help it conquer the rooftop market while First Solar's lower-cost and lower-efficiency panels are better suited for traditional utilities.

Both First Solar and SunPower are interesting investments. On the surface First Solar looks less risky with its small debt load and total debt-to-equity ratio of 0.06, compared to SunPower's 0.95. It is important to remember that SunPower is majority owned by the French oil giant Total, so the company has more room to play with its balance sheet.

The other side of the coin
Yingli , Suntech , and LDK Solar are all Chinese manufactures that are reaping the fruits of too much money. The Chinese industry expanded production for far too long, driving some firms like Suntech into bankruptcy. Suntech is trying to stage a comeback, but among other issues its R&D budget simply cannot compete with the spending of its bigger competitors.

Based on its latest 2013 numbers, LDK Solar is also stuck in a rough spot with huge operating losses. Yingli was not forced to declare bankruptcy like Suntech, but it is still in a tough situation. Quarter over quarter, Yingli saw its recent panel shipments increase 23.6%, but it was still stuck with an operating margin of -3.8%.

The bottom line is that it is hard to justify increasing R&D spending while running operating losses. Low R&D spending limits a company's long-term ability to improve its products and compete. Based on recent quarterly statements available for Yingli, Suntech, and LDK Solar, every Chinese manufacturer was stuck in a situation where its R&D spending and earnings are below the standards set in the U.S.

Conclusion
Big R&D spending improves products and allows a company to gain an advantage over its competitors. While U.S. manufacturers like SunPower and First Solar don't have access to cheap capital like many Chinese manufacturers, their strong R&D budgets give them a significant advantage. A combination of improving profitability and continued R&D spending make investing in U.S. solar manufactures an attractive proposition.

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Joshua Bondy has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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