Despite all the recent negative publicity surrounding solar power, such as diminishing government subsidies due to austerity measures and the Solyndra scandal (the Obama administration gave the company a $528 million loan as a part of the 2008 stimulus package, whereupon the company later went belly-up), the U.S. solar-power industry is doing better than many expected.

Solar companies are evolving, and their stocks may now be at reasonable buying levels.

After the spectacular collapse of Solyndra, Evergreen Solar and Intel (Nasdaq: INTC) spinoff Spectrawatt, the perception is that the U.S. solar industry, despite government loans, is in a death spiral. But, to paraphrase Mark Twain, reports of the demise of the U.S. solar industry are greatly exaggerated.

According to the Solar Energy Industries Association, the solar-power industry in the United States employs more than 100,000 people, more than double the levels of just two years ago –and more than the steel or coal mining industry.
 
In its regular quarterly assessment, the Association stated investment in solar power should add about 1,750 megawatts of capacity in the United States in 2011, up nearly double from 900 megawatts last year.

It also said the industry’s trade balance was in the black last year, to the tune of $1.9 billion. This year, industry observers believe the trade balance will shrink and still remain in the black, but barely. This is significant because it shows the U.S. industry is still competitive globally. 

Sector to avoid
The market segments and technologies within the solar industry where money can be made are changing — a very important point for investors to grasp.

The worst of the current gloom in the solar sector is concentrated in one particular segment — the manufacture of solar modules.

This labor-intensive business is dominated by Chinese competitors such as Suntech Power (NYSE: STP), Trina Solar (NYSE: TSL) and Yingli Green Energy (NYSE: YGE). Massive expansion by Chinese companies and others has led to a huge oversupply of solar modules. In fact, there is enough capacity to supply more than twice the expected global market demand this year.

As a result, prices of modules have plunged, dropping to only $1.43 per watt of generation, from $3.50 per watt in 2008. Obviously, this is a sector for investors to avoid.

Two solar stocks to consider
There are U.S. companies that have smartly moved away from this sector and moved downstream, that is, moved into project development and engineering, along with procurement and construction.

The maker of silicon wafers — MEMC Electronic Materials (NYSE: WFR) — began buying solar-power developers in 2009 to build up its pipeline of project business and insulate it from the down times in the manufacturing side of the business.

Another company moving downstream is First Solar (Nasdaq: FSLR), the world’s largest solar company by stock market capitalization, and best known as a thin-film solar module manufacturer.

Like MEMC, First Solar has also been shifting into project development and engineering contracting. This business will provide about a quarter of its estimated $3.7 billion in net sales this year, roughly the same amount as First Solar will get from the solar module sales for these projects.

Management at First Solar forecasts downstream activities and tied module sales (sales tied directly to solar development and engineering projects which First Solar controls) will grow to two-thirds of total revenue within a year.

Of course, being vertically integrated is not a cure-all. But as recent industry history shows, it does help insulate companies.

The fall in solar module prices has still scorched these companies’ stock prices. During the past three years, First Solar shares have fallen more than 60%, while MEMC shares have dropped more than 85%.

But both companies are still in business, and they are poised to benefit tremendously during the next up-cycle in the industry.

Ironically, the fall in module prices is stimulating demand for solar power and making the industry more competitive against fossil fuels. In some sunny markets like California, the industry says solar is now at or close to the point where it can compete with natural gas-fired power plants at peak times during the day. According to industry leaders, the industry is expected to be able to compete at peak hours with fossil fuels without government subsidies within three years.

California is expected to source a third of its electricity from renewable power by 2020. It currently has only 300 megawatts of solar capacity installed, but plans have been announced to add 16,500 megawatts more in the next several years.

Risks to Consider: The U.S. solar industry is still under tremendous competitive pressure from Chinese companies. Solar power module prices are likely to continue to drop. Also, due to the Solyndra scandal, future subsidies from the government are in question, however, it does remain a top priority of the Obama administration.

Action to Take–> Some U.S. companies like First Solar and MEMC are making substantial changes to their prior business plans and are now becoming more vertically integrated. This should protect them to a degree from falling prices and allow them to survive. Recall that even in this terrible down period for the industry solar capacity doubled in the United States in the past year. The few companies remaining will have the field all to themselves in a rapidly growing industry. Investors may want to pick up shares of these survivors while they are trading near their 52-week lows as a long-term investment.