Will Chinese Solar Stocks Go Boom or Bust?

By Markets Fool.com

Chinese solar stocks have had a wild ride over the last five years, and most recently have lagged the market by a wide margin. Leaders like Canadian Solar , JinkoSolar , Trina Solar , and Yingli Green Energy have all plunged along with most solar stocks this year.

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CSIQ Chart

CSIQ data by YCharts.

Yet, the solar industry is set to surge around 35% this year to 50 GW worldwide and analysts are expecting double-digit growth again next year. That should mean strong results for Chinese solar stocks, shouldn't it?

Why 2015 could be a boom year

One of the dynamics that sank the solar industry in 2012 was a vast oversupply of solar panels. The solar industry had about 70 GW of solar manufacturing capacity in 2012, yet only 32 GW was installed, which was actually up from 27.4 GW a year earlier, so the industry was growing despite being oversupplied. This oversupply lead to a bust cycle in 2012, but it's also driving a boom in installations in 2014, a dynamic that will become important later.

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For solar companies' financials, the result of overcapacity in 2012 was rapidly falling prices for solar modules and lower margins, and massive losses for solar suppliers, as you can see below.

CSIQ Net Income (TTM) Chart

CSIQ Net Income (TTM) data by YCharts.

2014 has been a far better year financially speaking, especially for Canadian Solar, JinkoSolar, and Trina Solar. They're not only enjoying stable to slightly rising module sale prices, they were all among the first Chinese suppliers to get into solar project development business. Canadian Solar in particular moved quickly to exploit the highly lucrative Ontario solar market, where it's selling projects that are likely in excess of 50% gross margin.

If demand continues to grow, and supply can't keep up, margins for modules and systems will continue to rise, and so will profits. That's why next year could be a boom year for solar investors. But there are already signs the boom may not last long.

Why the Chinese solar market could bust

Before you start assuming there's only positive news on the horizon for Chinese solar companies, consider the negatives they'll be facing next year.

Japan installed 7 GW of solar last year and projects to install 9 GW in 2014, which could lead to a sharp cut in the country's feed-in tariff (FIT). This market has been a boon for companies like Canadian Solar, who moved quickly to sell there, and a cut in the FIT next year could be devastating.

A Yingli Green Energy solar panel. Source: Yingli Green Energy.

The U.S. is predicted to be about a 6.5 GW market this year, but it's increasingly moving away from Chinese solar panels. Import tariffs put in place this summer show no signs of being lowered, and even if the market is large, it may be a low-margin market for Chinese suppliers. SunPowerand First Solarhave major share here, and SolarCityrecently signed a deal with REC Solar and is building a domestic manufacturing plant to supply its own modules. Long term, the U.S. may not be a big demand market for Chinese panels, another hit to demand.

Then there's capacity expansion, which Chinese companies are doing despite the industry's struggle with capacity over the past five years. Canadian Solar is adding 500 MW of modulecapacity, 400 MW of cell capacity, and 140 MW of ingot and wafer capacity in China early next year. Trina Solarhas announced a joint venture that will produce 500 MW by the end of 2015 and the acquisition of 420 MW of capacity. JinkoSolar is planning to add 20% to 25% to capacityin 2015. These are just a few of the expansions planned for the next year.

Chinese solar companies can't seem to get out of their own way when it comes to capacity and certainly didn't learn lessons from the bust in 2012. They build more and more capacity until the market crashes, and get back to building again before the market fully recovers, which is a recipe for losses over the long term.

If there's one reason these stocks will bust, it's because they're building capacity now instead of capturing profits and paying down debt while they can.

What to do with Chinese solar stocks now?

The financials of some Chinese solar companies look enticing right now, with P/E ratios below 10, but be sure to understand where their profits have come from in the past year. Lucrative sales in Canada and Japan may be short-term wins, and lower margins could return in 2015 if manufacturers oversupply the market again.

I'm wary of another bust cycle just as some of these manufacturers are building capacity again. Only time will tell whether it's boom or bust for Chinese solar.

The article Will Chinese Solar Stocks Go Boom or Bust? originally appeared on Fool.com.

Travis Hoium owns shares of SunPower. Travis Hoium has the following options: long January 2015 $5 calls on SunPower, long January 2015 $7 calls on SunPower, long January 2015 $15 calls on SunPower, long January 2015 $25 calls on SunPower, and long January 2015 $40 calls on SunPower. The Motley Fool recommends SolarCity. The Motley Fool owns shares of SolarCity. 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.