The solar industry has taken it on the chin, for good reason if you ask me, in the last 8 months or so, but lately, I feel that there is something to look at here, with possible best of breed companies working through the malaise to offer us tempting prices for those with long term investing horizons.

Specifically, I’ll be looking at several companies that seem strong, even in the face of a decline in demand, eroding margins, and financing difficulties that are making large scale solar projects harder to implement.

What Went Wrong?

Here’s a very brief rundown of the problems that have befallen the entire solar industry for about the last year or so that have caused the stocks of companies in this market to plunge:

• Increased Supply: It’s no secret that everyone and their mom started a solar company within the last 3-5 years, with the last 2 years showing incredible venture capital being pumped into the sector.

As a result, solar panel manufacturers of all types, from thin film to standard rooftop panel producers, have flooded the market with more and more product. I don’t have to tell you what this does to prices.

• Increased Supply 2: In addition, more and more polysilicon, the building block of most of these panels, went from being in short supply, to being overabundant as well within the last year or so as more companies are opening shop in the polysilicon business, as well as existing manufacturers putting out more and more of the raw material.

Spot prices for polysilicon have dropped to around $100 a kilogram after soaring to $500 a kg last year.

One of the companies in this space is MEMC Electronic Materials (NYSE: WFR), which has seen incredible demand erosion, as well as margin contraction because of lower spot silicon prices.

• No Financing: The increased supply mentioned above was not a problem so long as all of that supply was being eaten up by ravenous customers around the world.

Lately, even though that demand is inherently there, the ability to finance that demand has eroded considerably, to the point where getting the necessary capital for a large scale solar project has become almost impossible.

The financial crisis has hit the solar industry in one of the most unsuspecting ways: nobody can get capital to finance solar projects, EVEN THOUGH those projects are profitable from day 1, and last up to 30 years and will pay for themselves many times over.

• No Financing 2: Along those same lines, even with the generous government incentives that were just passed with the economic stimulus package, retail customers are reigning in their spending ways as well, and not putting solar on their roofs as rampantly as they were before not just because of the aforementioned lack of financing, but also because of fear of the down economy, uncertainty about property values and other related factors that would stop someone from a massive cash outlay of that magnitude, EVEN THOUGH solar panels on homes increase resale value, and again, pay for themselves many times over.

• Decreased Demand: Two of the largest solar installers were Spain and Germany (of all places!). That spigot has been shut off, or at least turned way down.

The governments of these two nations have curtailed their spending spree towards solar after large build outs and incentive programs aimed at ramping up installations in their countries and to get into the whole Green Movement.

These incentives have been scaled way back, and in some instances cut entirely, leading to further reduced demand.

• Decreasing Margins: What happens when you can’t sell inventory and you have more on its way? Yea, you have to cut prices to get rid of what you got. This has been widely reported already, with SunPower (NASDAQ: SPWRA), (NASDAQ: SPWRB), reporting last week that they wrote down the value of their inventory because of this exact reason.

Further, analysts expect, and SunPower reported, that prices will likely come down another 20-50% depending on the company, what type of panels they make, and what they paid for polysilicon when prices were much higher.

What’s Going Right?

It’s not all gloom and doom though. There are some signs that things are at least stabilizing, and a recovery is in place.

In addition, who believes that the solar industry is irreparable and that these companies are doomed?

We all know that it is only a matter of time before solar comes back because of the worldwide movement towards cleaner alternative energy sources.

Here’s some reasons why things aren’t as bad as they seem:

• Demand Stabilizing: As reported by several companies already, there has been a stabilization in demand, although they still foresee pricing pressure throughout 2009.

Both MEMC and SunPower reported that demand seems to have stabilized and MEMC reported a slight uptick in demand for polysilicon in the first half of Q2.

• The Weak Will Fall: We’ve already seen several companies exit the business over the last few months, and get bought out by other larger competitors, such as the recently announced deal of First Solar (NASDAQ: FSLR) when it purchased OptiSolar and its assets.

There have been other companies closing shop lately, and this is standard procedure for boom and bust times.

This will only leave the strongest standing, and in better position to corner the market when things turn around.

• Getting Leaner: The companies that remain are getting leaner. Both SunPower, MEMC and others in their industry have announced some combination of reduced staff, reduced output, lower capital expenditures, lower overhead, and tighter cost controls. These are probably items that needed to be addressed long ago, but the current environment is providing the impetus for these changes.
• China On The Rampage: China has decided to enter the grand subsidy game by announcing huge potential incentives for large scale solar projects which could greatly benefit Chinese solar companies like Yingli Green Energy (NYSE: YGE) and Suntech Power (NYSE: STP). What remains to be seen is whether or not these incentives have a cap, how they will be structured, etc.
• Results Not Spooking Investors: As we’ve seen in the last few weeks, these poor results and the solar stocks missing estimates badly and lowering guidance and expectations, hasn’t caused their stocks to decline anymore.

It appears that these stocks have been priced for these declines and skepticism, and just Friday, SunPower’s stock was down only modestly, after absolutely blowing their earnings announcement, and lowering full year guidance and projections, as well as writing down inventory.

• Long Term Boom: As I mentioned above, long term, solar is here to stay, and is only going to proliferate more and more places that are seeking ways to take advantage of this alternative energy source.

Unlike other industries that have fallen on hard times, the solar industry is just in a temporary lull, and will come roaring back in very short order.

• Charts Looking Good: I am not one for technical analysis on its own, but along with the news that demand may be stabilizing, and solar stocks might be working through their problems in good fashion, a look at the charts shows that most of these companies have stable chart patterns, and have stopped hemorrhaging losses with every little bad news announcement.

If I do decide to purchase shares of any company mentioned (more below), it would be with strict rules such as taking no more than a 15% loss, etc.

If the whole sector gets even more margin contraction, and prices plummet to a new “stable” level, you don’t want to be around for that, which could entail a 50% decline.

But as of right now, the entry point looks solid all things considered, and represents a fantastic contrarian play, as analysts are tripping over themselves to lower expectations, earnings projections, price targets and lowering their ratings to “Holds” and “Sells” as fast as they can.

This excites me tremendously, especially with a sector like this that has long term promise regardless of what is happening right now.

Now let’s look at some solar names to consider right now:

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