We have been positive on shares of First Solar (FSLR) for some time, arguing that it is the best way for investors to gain exposure to the long-term growth potential of the global solar energy market. Our last article on First Solar was published on August 2, 2012, and readers who heeded our buy recommendation in that August piece have seen returns of over 74% (versus 9.56% for the S&P 500) through the close of trading on Wednesday, February 27, 2013. And while First Solar's guidance for the first quarter came in below expectations (more on that later), we believe that investors should approach First Solar from a long-term perspective, and we break out our thesis below. Unless otherwise noted, financial statistics and management commentary will be derived from one of the following 4 sources:
- First Solar's Q4 2012 earnings release
- First Solar's Q4 2012 earnings conference call
- First Solar's Q4 2012 earnings presentation
- First Solar's 2012 10-K
Q4 2012 Overview
First Solar posted pro forma EPS of $2.04 and revenues of $1.075011 billion, figures that posted mixed results relative to consensus estimates. While EPS of $2.04 easily beat estimates of $1.76, revenues missed estimates by $240 million, due in part to the timing of revenue recognition related to the company's project backlog. In Q4 2012, revenues grew by 62.79%, and pro forma EPS grew by 61.9% year-over-year. While gross margins fell sequentially by 110 basis points to 27.31%, they expanded by 639 basis points year-over-year. First Solar's full-year gross margin fell to 25.32% from 35.1% in 2011. However, we caution that such gross margin levels were likely unsustainable, and not reflective of the long-term profile of First Solar's solar business. Operating margins however, came in at 14.6% for all of 2012, versus 13.92% for 2011, reflecting the improvements that First Solar has made in its operating cost structure.
However, what unnerved investors was First Solar's guidance for Q1 2013. The company expects revenues of $650-$750 million, and EPS of $0.70-$0.90, both of which missed consensus estimates that called for revenues of $829 million and $0.94 in EPS. This miss in guidance, when combined with the rally that First Solar's stock has had in recent months, caused shares to fall sharply on Wednesday, February 27. However, we believe that this decline should be seen as a buying opportunity. First Solar's management team spoke of the opportunities it sees in the years to come on its conference call, and First Solar's financial position (which we will discuss later in the article) leads the sector, with $253.3 million in free cash flow in Q4 2012, and $329.7 million in full-year 2012 free cash flow (the company forecast operating cash flow for Q1 2013 of $0-$100 million. Q1 is a seasonally light quarter in terms of operating cash flow, and in Q1 2012 First Solar posted operating cash burn of $16.136 million).
Underlying Panel And Business Trends
In Q4 2012, cost per watt at First Solar came in at $0.67 (when underutilization is added back, cost per watt rises to $0.68), a sequential increase of 3 cents, but a year-over-year decline of 8 cents. The company's best plant produced a total cost per watt of 64 cents, up 2 cents sequentially, but down 9 cents year-over-year. CFO Mark Widmar stated that the company's sequential cost per watt increase was due to several one-time factors, including the costs of re-ramping certain production lines. We believe that First Solar's cost per watt will continue to improve throughout the course of 2013, and expect more color on these trends at First Solar's 2013 analyst day, currently scheduled for April 9. Total balance of systems costs fell 14% in 2012, and CFO Mark Widmar stated that he expects balance of systems to continue in the long-term. First Solar's management team spoke of a dynamic and competitive business environment in Q4 2012, and that it is responding accordingly. While this is reflected in the company's Q1 2013 guidance, we believe that in the long-term, First Solar will overcome these issues.
On the call, CEO Jim Hughes spoke of competitive pricing, driven not by other solar companies, but by "traditional EPC providers that have come into the space and are competing using modules other than our own. It's been less of seeing the other module manufacturers expand their offering to include systems." CFO Mark Widmar added that First Solar has been aggressive on pricing when bidding for new contracts, and this is likely included in the company's Q1 earnings guidance. However, he also noted that while First Solar's margins may be pressured in the short-term, the longer-term margin outlook (in terms of operating margins) is more positive. He stated that, "as we get further out on the timeline and you have the benefit of not only the enhancements that we're making on the module side but also the enhancements that we're making and significantly driving down our BoS cost, the margin profile starts to be more attractive and more consistent with what we would be targeting." CFO Widmar also noted that First Solar's balance sheet enables the company to bid on projects that other companies may not be able to sustain in the long-term, given the current dynamics of the solar market.
Alongside its Q4 2012 earnings, First Solar announced that it has achieved a new record in term of CdTe panel efficiency, with the company's panels achieving efficiency of 18.7%, using processes and materials that are ready for full-scale commercial manufacturing (CEO James Hughes stated on the call that he will provide an in-depth overview of the company's panel efficiency at its April 9th Analyst Day). While Q2 2013 is set to be stronger than Q1 2013, according to CFO Mark Widmar, the 2nd half of 2013 is set to be weaker than the 1st half, driven by a higher mix of third-party module sales relative to system project sales in the 2nd half. Full-year guidance for 2013 will be provided at the company's Analyst Day. For 2013, it is difficult to explain expected weakness in the 2nd half of 2013. However, we recommend that investors look beyond 2013, just as First Solar is doing, for 2014 and the years beyond are what will define the company's long-term opportunity.
First Solar is continuing its expansion into new, sustainable solar markets. The company has set up a new South Africa and sub-Saharan Africa division, headed Johan Cilliers, who was previously Suzlon's vice president of sales and marketing, and has worked in the energy divisions of both GE (GE) and Siemens (SI). Ahmed Nada has been recruited to head the company's Middle Eastern business, and he joins First Solar from GE, where he was regional manager of its Middle Eastern Oil and Gas Global Services division. First Solar's management team took time to address its business in India, noting that it is in discussions with the Indian government regarding local content requirements for thin film panel manufacturers, and noted that local panel manufacturers are operating at "almost no capacity utilization" due to these requirements.
However, CEO James Hughes noted that First Solar does not see these requirements as a meaningful barrier to the potential of its Indian business, and that the company sees ample potential outside of state sponsored solar programs. First Solar is also working to expand its presence in China, and has completed supply shipments on a 2 megawatt project with Zhenfa, one of China's largest photovoltaic power generators, CEO James Hughes noted on the company's Q4 call that First Solar is in negotiations to expand its partnership with the company throughout China. Chile serves as another example of First Solar's efforts to "localize" its target markers. On January 9, 2013, First Solar acquired Solar Chile, whose total project pipeline currently totals 1.5 gigawatts in Northern Chile, which has the highest levels of solar irradiance in the world. First Solar has been able to expand across the world while still lowering its operating expenses to a quarterly run rate of below $100 million (Q1 2013 guidance calls for operating expenses of $90-$100 million), with total 2012 operating expenses falling by 28.28% to $421 million. We expect much more color regarding First Solar's globalization strategy at its April 9th Analyst Day, and in our view, there is ample opportunity for the company to expand around the globe, for the long-term demand for solar energy is growing, and as First Solar's costs continue to fall, the company should see long-term success.
Financials, Peers and Forecasts: First Solar is First Among Equals
As we have stated multiple times, First Solar's financial position within the solar sector is unrivaled. The company's Q4 2012 results confirm this, as do the results of sector peers that have reported their Q4 2012 results. SunPower (SPWR) and Trina Solar (TSL) have already posted Q4 results, and the rest of the sector is set to report throughout March. We break down the Q4 and full-year 2012 results of First Solar relative to its peers below.
Solar Sector Q4 & 2012 Results (in Thousands of Dollars)
Q4 2012 Revenue
Q4 2012 Gross Margin
2012 Gross Margin
Q4 2012 Operating Margin
2012 Operating Margin
Q4 Operating Cash Flow
2012 Operating Cash Flow
Cash & Investments
Net Cash & Investments
*Trina Solar did not disclose full-year operating cash flow on its conference call, and its 20-F for 2012 has not yet been filed
As the table above shows, First Solar's financial position leads the sector, allowing the company to invest in its business in ways that its competitors cannot. Weakness in the global solar market is beginning to take its toll on sector. LDK Solar (LDK) has already received what critics call a bailout from the city government of Xinyu, and Suntech (STP) is in talks with the government of Wuxi about financial assistance as it's over $500 million of debt is set to mature in March. Ironically, solar industry observers note that financial assistance from the Chinese government (across a variety of levels) is actually impeding the Chinese solar sector's ability to become more competitive. However, socio-political considerations are forcing the Chinese government into a difficult position. China's state banks (led by China Development Bank) are owed billions of dollars by China's solar industry, and are pressuring local governments to intervene in order to ensure that they are repaid, going so far as to threaten a halt on all lending to the regions in question until these solar companies receive financial assistance. Many of First Solar's competitors (especially LDK and Suntech) are seen as insolvent under Western standards, and consensus earnings forecasts for the sector do not imply a substantial improvement for First Solar's peers.
Solar Sector Consensus Forward Estimates
Of the 10 firms listed above, only First Solar is set to be profitable every year through 2015, and even in 2015, it is one of only 4 firms forecast to post a profit. First Solar's profits are set to bottom out in 2014 at $3.42 per share, as it runs through its existing backlog of utility projects. But, even at its low point in term of profits, First Solar trades at just 7.91x 2014 EPS (based on its February 27 closing price of $27.04), hardly levels that can be called expensive (the stock currently trades at 6.64x estimated 2013 EPS). However, a discussion of First Solar's valuation is incomplete if its cash position is not mentioned. First Solar currently has 87,156,517 shares outstanding, which gives the company $5.06 per share in net cash. Based on its current share price, almost 19% of First Solar's market capitalization consists of cash, and the company trades at an ex-cash P/E ratio of 5.4x 2013 EPS, and 6.43x. In addition to modest forward P/E multiples, First Solar trades at sizable discount to book value, which currently stands at $3,605,526,000 or $41.36 per share. At current prices, First Solar trades at a price/book multiple of just 0.65x. And First Solar's book value is set to grow in the quarters to come, driven by continued profitability and cash generation. In its post-earnings downgrade of First Solar, Merrill Lynch noted that First Solar is set to see substantial operating cash flow over the course of the next 2 years, and estimates that the company's cash position could reach $2 billion by mid-2014, which is nearly equal to the company's present market capitalization of just over $2.35 billion. And while Merrill Lynch downgraded First Solar due to lowered "intermediate term" earnings estimates, the firm noted that "First Solar looks to have plenty of cost leverage, and we don't necessarily disagree with the company's strategy over the longer term ... The combination of reduced capacity and increased efficiency should allow First Solar to drop its cost per watt to the low $0.60s according to our model, or the low $0.50s excluding the freight and warranty charges that Chinese competitors typically wrap into operating cost. Armed with that cost structure and still-decent margins from the project backlog, it makes sense for First Solar to start leaning on the market a little more." Merrill Lynch notes that the company's long-term strategy makes sense, and that the company's growing cash balance will provide support to the company's shares.
Our bullish thesis on First Solar has never been about the "intermediate term." We have consistently argued that First Solar should be seen as a long-term investment, where the company's present profits will be used to invest in its future. First Solar leads the solar sector in terms of financial strength, consistency of profitability, and is executing across multiple channels to position itself for long-term growth. The company is expanding its global presence, with a focus on the markets where favorable solar conditions intersect with growing demand for electricity. First Solar's valuation is unassuming, with a P/E ratio in the single digits, and a stock trading well below its book value, and we believe that as First Solar shows signs of long-term progress, the company's multiples will expand. With over 30% of the stock's float sold short, skepticism surrounding First Solar is quite high, despite the fact that such levels of short interest are usually reserved for unprofitable companies burning cash, and not companies that are forecast to remain profitable for years to come. We believe that as a company, First Solar's best days are ahead of it, and view this decline as a long-term buying opportunity, and think that investors who add to or initiate positions at these levels will, in time, be rewarded for their conviction.