For Chinese Solar Stocks, Correction or Reversal?

Chinese solar stocks have taken it on the chin lately. The sector leaders, Trina Solar , JinkoSolar , and Canadian Solar are down significantly from their 52-week highs. Here are three reasons why the retracements should not be reason for concern.

Normal consolidation for a high-beta sector
After breathtaking rallies, it is normal for stocks to retrace significantly before continuing their trend. A 33% decrease would be reason for significant concern for any other sector, but for solar stocks, it should not be a big concern. The solar sector has always been very volatile. The underlying long-term fundamental trends have not changed. It is only investor appetite that has. Investor appetite is fickle and could reverse again.

China needs renewable energy
In China, coal is dirty and natural gas is expensive. Both require a lot of water, something that China does not have in abundance. 

Solar panels do not need water to produce electricity. They can be placed on rooftops to save valuable land. While solar is still on average more expensive than coal and natural gas, solar's decreasing cost over time will eventually make it a great solution. 

China has a lot of pollution -- clearly. Sixteen out of the world's 20 most polluted cities are Chinese.  It needs to reduce its dependence on coal, which currently makes up 79% of electricity generation.  China also needs to lessen its energy dependence so that Middle Eastern instability doesn't lead to its own instability. Solar helps solve all three problems.

The Chinese government is committed to the solar sector
In my opinion, the Chinese government is to the Chinese solar sector as Ben Bernanke was to the banks in 2009. Just as Mr. Bernanke did whatever he could to prop up banks and nurse them back to health, the Chinese government will do whatever it can to make national champions out of solar companies. Mr. Bernanke realized that if banks are healthy, the entire economy moves forward, moral hazard be thrown to the wind. The Chinese government realizes that if its leading solar companies are healthy and growing, its entire economy will do better.

The higher the stock price for solar companies, the healthier the companies are. The healthier the companies, the faster they grow. The faster Chinese solar companies grow, the more innovation is produced and less pollution in the atmosphere. According to the World Bank, the total cost of air and water pollution in China is around 5.8% of GDP.  

Renewable energy is a strategic sector for China, and the Chinese government is notorious for thinking long term. The Chinese government has already lowered VAT taxes, provided lower interest loans to solar companies, and banned increasing capacity for 2013. If it needs to do more, in my opinion, it will. 

The bottom line
Warren Buffett is famous for being a long-term investor. He buys quality stocks that benefit from secular trends and holds them forever. Mr.Buffett buys stocks of companies of which he is sure of future cash flows, even if the market may not be sure of them. If his stocks go down 40%, Mr. Buffett does not blink when others do. 

Solar companies are clearly different from what Mr. Buffett likes to buy. Solar companies are highly volatile growth stocks that do not have predictable cash flows. They do, however, have long-term trends going for them, and the Chinese sector leaders, JinkoSolar, Trina Solar, and  Canadian Solar all have great promise.

With the Chinese government behind them, they will not go out of business. As solar costs come down, they will see increasing demand and healthier margins. As solar companies move more into providing distributed power solutions, the solar companies of the future are likely to be similar to the utility companies of today, both with sustainable cash flows that Mr. Buffett looks for.

Despite the recent bearish conditions, I think the long-term thesis for the leading Chinese solar companies is still on track.

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Jay Yao 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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