We last wrote about First Solar (FSLR) on April 10, a day after its long-term guidance sent shares soaring over 45%. We argued that even with the rally there is further long-term upside to be realized, given the company's industry leading financial position and the market opportunities that lie ahead. However, we cautioned that a near-term pullback was possible, given the stock's surge April 9. But so far, this has not happened. Since its analyst day, shares of First Solar have rallied around 14%. Although short interest has dropped, from over 30% to around 27% as of April 24, the unwinding of short positions is but one of the drivers of First Solar's continued rally. Favorable developments, both in Washington and China, serve to highlight the long-term opportunity that lies ahead for First Solar.
Mr. Renewable MLP Goes to Washington, and Finds Bipartisan Support
The bulk of First Solar's post-guidance rally occurred April 24, with shares rallying nearly 12% as the MLP Parity Act was reintroduced in Congress. This legislation is fairly simple, and alters the tax code to allow renewable energy projects to qualify for master limited partnership status, the same status currently afforded to oil, gas, and pipeline projects. Although we rarely discuss the political issues of renewable energy, given our belief that politics and investing should not be mixed, we feel that here, a political discussion is appropriate, due in large part to the fact that the MLP Parity Act has generated little in the way of political controversy. Although Senator Chris Coons (D-DE) introduced the bill, its cosponsors include Senator Debbie Stabenow (D-MI), Senator Lisa Murkowski (R-AK), and Senator Jerry Moran (R-KS). The bill has bipartisan support across the ideological spectrum; Lisa Murkowski and Jerry Moran are among the more conservative members of the Senate, with Senator Murkowski garnering a lifetime score of 65.03 (out of 100) from the American Conservative Union's ranking of the Senate's conservatism.
Senator Moran's lifetime score is 90.1, placing him in the upper strata of the Senate's conservative spectrum (as expected, Senators Coons and Stabenow are on the opposite side of the spectrum, with Senator Coons garnering a lifetime score of just 1.33, and Senator Stabenow performing slightly better with a score of 8.33). In addition, the MLP Parity Act is also supported by the American Petroleum Institute, the main lobbying group for the petroleum & natural gas industry, as a way to "wean" the renewable energy sector away from federal subsidies. As expected, the renewable energy industry is enthusiastically supporting this bill. However, industry support is also coming from other companies as well, including NRG Energy (NRG) and DuPont (DD).
Although this bill has been brought up before, it languished in committee in the previous session of Congress, failing to advance to the floor. However, we doubt that Senator Coons would reintroduce this bill without a more meaningful plan of action to move the bill through to passage. The bill has support from two conservative Senators, as well as the leading lobbying group of the oil and gas industry, as well as other private sector stakeholders. And Senator Murkowski has gone on record as stating that the bill has broader bipartisan support in both chambers of Congress. While some analysts have expressed skepticism about the bill's ability to pass, we believe that the probability of its passage is higher than in the previous Congress, and that should the MLP Parity Act become law, it is likely to provide meaningful benefits to the industry, with some analysts estimating that it could cut the cost of capital for renewable energy projects by 30%-50%.
Continued Deterioration of Chinese Competitors
While the MLP Parity Act is a positive development for First Solar, it is not the only favorable development that has taken place since the company's analyst day. News out of China regarding several of the company's competitors has been relatively bleak, and highlights the tenuous financial position of many of these companies. On April 23, news broke that lenders of Sunways, a majority-owned subsidiary of LDK Solar (LDK), have terminated all credit lines to the company, with Sunways itself stating that its lenders have exercised their rights to the collateral securing those credit lines. And LDK Solar itself is faring little better. The company posted its Q4 2012 earnings on April 18, and although the company badly missed on revenues (Q4 revenues came in at $135.898 million versus consensus estimates of $263 million), that is not the main issue at LDK Solar. The company's cash balance has fallen to $283.313 million, a decrease of $200.017 million compared to Q3 2012.
LDK has $240 million of debt due in June, and as of Dec. 31, 2012, over $2 billion of debt is set to mature over the course of the next 12 months. However, investors need not wait for LDK to default, for that has already begun to occur. LDK missed a $23.8 million bond payment on April 16 due to what the company termed "a temporary cash flow shortage," as it reached a settlement to delay payment on $16.6 million of debt, and remains in talks regarding the remainder of the balance. However, with $2 billion in debt set to mature over the next year, LDK will likely have a difficult time dealing with its debt burden. And there are signs that China's government is shifting its stance on government assistance to the solar industry.
In December, China's State Council (the country's version of a cabinet) signaled its intention to halt support of unprofitable solar producers, and instead focus on consolidating the industry. But more importantly, the State Council hinted that it might bar municipal governments from supporting failing solar companies (LDK has already received what many see as a bailout from the city of Xinyu), and the city of Wuxi is set to take control of Suntech's (STP) operating subsidiary. Over the next 12 months, we believe that the Chinese solar industry will undergo dramatic changes, as billions in debt is set to mature, forcing the Chinese government to make a choice as to whether or not it will continue supporting the sector. The table below details the financial conditions of the major publicly traded solar companies and their debt maturities (Suntech will be excluded from this table, for the company has not reported earnings since Q1 2012).
Solar Sector Balance Sheets (in Thousands of $)
Cash & Equivalents
Total Cash, Equivalents, & Restricted Cash
Net Cash & Equivalents*
Current Net Cash & Equivalents**
*Net cash and equivalents includes restricted cash for all companies other than First Solar; **Cash, equivalents, and restricted cash less current debt for all companies other than First Solar.
As the table above shows, 2013 is likely to be a watershed year for the global solar industry. Much of the Chinese solar sector (as well as Canadian Solar, based in Ontario) is operating with a working capital deficit, and with the exception of First Solar and SunPower (SPWR), no other company in the sector has enough cash on hand to meet their current debt obligations, and that assumes that cash balances do not continue to fall. Billions of debt is coming due this year across the sector, and we believe that this will force the Chinese government to make longer-term policy decisions regarding its domestic solar industry. Critics of First Solar will simply argue that the Chinese government will do what it has done before, and continue to rescue its solar companies. And in some ways, that may be true.
On April 23, Yingli Green Energy (YGE) became the latest solar company to receive assistance from the Chinese government, in the form of $165 million in loans ($110 million in one-year loans and $55 million in three-year loans). However, these assistance packages are not necessarily a positive for the Chinese solar sector. The Chinese government is caught in a catch 22. Its solar industry employs tens of thousands of people, and layoffs have the potential to stoke social unrest, a key concern for China's government. But as long as failing solar companies continue to receive assistance, nothing can be done to ease the global overcapacity issues that have plagued the broader solar sector. Samuel Yang, the CEO of Haeron Solar (listed in Shanghai) has said that, "China's solar industry is becoming like a prison… none of us are doing well. We are all locked in that prison."
We have been bullish on First Solar for some time, and throughout that time frame, we have heard critics of the company argue that its Chinese competitors will overwhelm it. However, so far, that has not occurred. First Solar's financial position is the strongest in the industry, and the company has more working capital than all of its publicly traded competitors combined. As the Chinese solar sector retrenches, focusing on finding ways to repay its debt and satisfy the needs of multiple domestic stakeholders, including municipal governments, China's central government, as well as creditors (both private and state), First Solar is focusing on expanding its global reach, customer base, and market potential, all while continuing to strengthen its financial position (the company's guidance for 2013-15 calls for cumulative operating cash flow of $2.35 billion). That being said, First Solar will also benefit from any potential consolidation in the Chinese solar sector, for this will serve to ease the overcapacity issues in the sector, as well as help drive up pricing within the sector, a favorable development for both First Solar and the broader solar sector.
With shares of First Solar up nearly 44% so far this year, and around 14% since its analyst day, we are somewhat hesitant to recommend that investors that do not yet own shares should invest at this precise point in time. That being said, we have not sold a single share of our position in First Solar, and believe that investors already in the stock should hold their positions as well. We view First Solar as a long-term holding, and an investment on the continued growth of solar energy both in the United States and around the world. As recent developments in China have shown, First Solar's competitors continue to weaken, all while First Solar continues to prove our argument that it is first among equals in the global solar industry.