by Hilary Kramer | October 25, 2013 10:00 am
First Solar (FSLR) is essentially a pure play on both the “front” end and the “back” end of the solar production chain, as opposed to large industrial players that may have a solar arm amid several other product lines. The company makes money from two main businesses: making solar panel components, and also in designing, manufacturing and selling solar modules to project and system developers.
The key customers for this segment are commercial entities and utilities, though FSLR is looking to make inroads into the residential market, too. It is this latter (systems) segment that will help propel the company’s operating results and share price higher.
Along with the rest of the industry, First Solar has had its own woes in the past few years, with shares reaching as much as $300 in 2008 before plummeting to $11 last year. But much like its sector mates, FSLR is in the midst of an attractive turnaround, and the stock has rebounded nicely to around $40.
It’s important to realize that much of the company’s slide over the past five years has been tied to FSLR’s presence in the module market, where its “thin film” solar technology (where less material is used to make more flexible panels at a lower cost) was sold to third parties, but became subject to a rapid drop in commodity prices. The company was also tied in to Germany’s solar power industry, which was among the leading countries (along with Spain and Italy) in adopting solar technology. These countries relied heavily on government subsidies to spur increased adoption of solar energy, and once Europe’s debt problems hit, those subsidies started to dry up.
However, FSLR has been diversifying away from Germany, where it once got as much as 65% of its revenues. Today, First Solar gets nearly 90% of its revenues right here in the United States. Where Europe once dominated the sector, recent numbers from industry analysts show that the U.S. solar market is indeed quite healthy and gathering steam. The U.S. share of global installations now represents 13%, which is up from 5% just five years ago. The Solar Energy Industries Association estimates the United States’ PV installations for 2013 will be up 30% from last year, and some analysts believe U.S. installations will double through 2015.
While this is an outstanding outlook for solar growth, the industry still deals with price competition. Installation prices continue to fall, as does the cost of selling the modules to installers themselves. Competition from China also has a role in pushing top lines and margins down across the solar food chain.
FSLR is not immune to this (gross margins have declined from a 60% peak to 27% today), but has weathered the pricing storm better than most. It has brought down the manufacturing cost of its modules from more than $1 a watt to about $0.67 a watt today, and that does indeed help margins. Critics may snipe at the efficiency disparity between thin film and more conventional polysilicon-based solar panels, where the percentage measures the efficiency or conversion of sunlight’s energy to electricity – for FSLR that ratio is about 15%, for other technologies it’s about 18%. But because the company can control its costs and lower its pricing, it can get its panels designed into large-scale solar projects.
As you might expect, declining “input” prices, including the cost of the technology that goes into the panels, means cheaper prices for the actual systems, and this in turn means more systems sold. First Solar clearly recognizes this, as it has focused on solar power systems. This segment represents 90% of FSLR’s top line, while the module business is 10%. Management has made sure it’s on the value-added side of the solar industry, and closer to the customers who actually use and install the power.
As I mentioned, the industry’s turnaround has not come without bumps, and FSLR has felt them in its quarterly results. Last quarter, revenue fell 45.7% from a year ago to $519.8 million (a miss of $200 million), and net income dropped 69.7% to $33.6 million, or 38 cents per share. Management lowered both full-year guidance of revenue to $3.6-$3.8 billion and earnings to $3.50-$4 a share, down 50 cents per share from three months ago. The earnings figure includes an equity offering and a new deal with GE which involved some additional share count, so they are not “apples to apples” with prior periods.
Shares pulled back sharply on the August report, but have been steadily rising ever since, supported by strong fundamentals. FSLR’s project pipeline is solid, with $9 billion in projects underway. Last quarter, the company bought General Electric’s (GE) solar technology for 1.75 million shares of stock. While that diluted shareholders a bit, it also means that FSLR is partnering with an industrial behemoth, which will provide some inroads into new markets.
A third-quarter equity raise of $427 million has helped FSLR pad its balance sheet to take advantage of the push for new solar installations – especially at a time when so many smaller companies are struggling with 10% gross margins, no profits, and who are leveraged to the hilt. Net cash stands at about $1 billion, which is 25% of the current market cap, and the company kept its operating cash flow target for the year of $1 billion (this is despite the revenue miss, which was based on some timing factors). In fact, the shares trade below net tangible assets, which is attractive from a valuation standpoint, as the stock trades below the liquidation value of the company.
Due to its strong balance sheet and positive cash flow, FSLR is positioned to weather any hiccups in the solar industry far better than its peers, and is also poised to capitalize on broader sector opportunities, no matter where they arise. Scale is key, and the company should be able to continue to grow its project pipeline, while monetizing its current projects that are already in construction. Though the guidedown in August was a disappointment, management remains confident that its pushed-out projects will be realized in 2014.
Street estimates have been lowered across the board, and now the company is viewed as a “show me” story. But I already see signs that FSLR will prove itself in the coming months, using its vertical integration model to outclass the competition. The stock may require some patience for its story to play out, but I believe the company can earn $6 a share by 2015, and given even a low 10X multiple by the Street, which may be conservative given that kind of earnings growth (but allows for investor skepticism), this could be a $60 stock in a year.
As I mentioned earlier, solar stocks are vulnerable to volatility, so I am giving First Solar a risk rating of aggressive. Please keep your risk tolerance in mind before buying.
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