Bargain of the Week: First Solar

First Solar Inc (FSLR) is by far the best solar company in the industry. They have a strong market share and also the best cost structure in the business. The management is pretty much the best in class. Since the beginning of the year, the Arizona-based company pretty much killed market forecasts easily. During the first quarter, First Solar made $1.99/share against an average estimation of $1.51. The stock rose on this news as management kept their forecast ($1.9 billion to $2.1 billion for the entire year) and had a cautious tone but were still optimistic enough to please the market. You have to admit that with a 48c beat, you can expect a market that would be happy, no?

Then came the 2Q, which was released a few days ago. Bearish analysts were all over the place with some "source check" that seems to see First Solar Inc losing some major customer. We could then expect a pretty surprise for their Q2 earnings. The stock even pulled back already from the Q1 earnings high (move down from $200 to $170). First Solar Inc announced just before the earnings call a big project with EDF ER in France, which is a new market that could become as important as Germany if you take into account the feed in tariff in place. The earnings finally came: The market expected a $1.62/share and the company comes with a very solid $2.11/share. You could expect another big increase (at least to the Q1 high no?). Well, the market sold off on the news. Why? Because management issued a rebate program in Germany for a certain part of their business there. It seems that the market didn't like that. Now the stock is around $150. I though it would be interesting to check why it was at this level:

• The rebate program will cost First Solar too much and hit their bottom line. Management, which is notoriously known for being very cautious (Apple-Like cautiousness), said that they think their full year forecast will stay in place even with the rebate.
• If you study the rebate program, you will see that it is a benchmark quarterly adjusted price. First Solar Inc made a very clever move on this one. They are aware that the market price is pressured on the downside because of the polysilicon inventory and the low poly price. They also think, and they are totally right on this one, that it will be a temporary issue, so instead of hurting their price structure for the long term, they applied a benchmark quarterly adjusted price. If you look closer at this system, it simply means that if some Chinese solar company continues to work on a negative margin by dumping price, First Solar Inc will adjust their price in consequence every quarter (on contract ALREADY signed with those conditions included). But we all know that Chinese solar companies won't be able to continue to leave on negative margin, so they will have to increase their price and therefore the quarterly adjusted price will work in favor of First Solar Inc. I wouldn't be surprise to see a very little effect on the bottom line for FSLR on this. But on the other side, they are able to conclude a deal with customer by giving them the warranty that if prices continue to fall they, will offer them a great price and if the prices doesn't move down, they will still have a fair price. So to sum up, people will be more interested in signing adeal with them as they will be sure to always get a fair price, whatever the market's spot price is. So I would like to know where is the bad effect on FSLR there?
• The actual growth of First Solar Inc between 08 and 09 is around 100% both in the top and bottom line. The P/E is around 20. Don't you feel something is wrong?
• People shouldn't forget that First Solar has, by far, the best cost structure in the business so they can support a temporary price cut that competition cannot now as they are already very tight in terms of margin and cost structure.

Now if we quickly look at the overall pros and cons of the company:

Pros :

• Great management
• Huge backlog
• Best cost structure in the business
• Best marketing network in the business
• Very high customer satisfaction
• Very conservative management
• Great brand value
• Amazing balance sheet (best in the business with GT Solar) with a debt/equity ratio at 10% and a cash level of $777 million.
• Best margin in the business (and will probably keep that advantage for many quarters at least)

Cons :

• Their product depends on very rare commodities that could see a big rise in price. But we don't know the real exposure in terms of cost on this component and also we don't know if the company has already a long term agreement to fulfill their needs at a decent price. I guess the cost impact on the overall cost structure is probably far below the silicon impact on polysilicon based panel.
• Tough competition on pricing with Chinese Solar Company mainly. But with their solid cost structure and their great idea of a rebate program (the way it has been built) should prevent them from facing a huge margin pressure.
• The overall weak credit market could hurt their business. Well so far no real effect has been seen specifically when you look at their huge growth year over year.
• According to channel check (that seems to be wrong so far), First Solar lost some major customer. The only news we found is they won a big project with EDF EN. But still we should still have a look on those inaccurate channel checks.
• Their panels need a big space to be as effective as polysilicon based panels because of their lower conversion rate.

I still believe that First Solar is the best solar company in the industry for years to come and right now it is a bargain for any long term investor. Due to the possible pullback of the market, it could be a good idea to build slowly your position on FSLR as it has a high beta with the market. For example, you should consider buying a small piece every month until you purchased the potential amount of stock you planned to own. You will get a very good average price for the long term.

And one more thing ....

When First Solar Inc gave their guidance, they said the currency rate assumption for Euro/USD is 1.15, and every 1c above has around $4 million positive effect on the company results. Do i need to calculate the actual positive effect since the beginning of the quarter is just based on the currency impact ?

With First Solar Inc, you have a leader in the upcoming very high growth market of solar energy (and renewable energy in general) with the best cost structure in the business and the best organisation. Also you own a company that has a very cautious management, which is a great thing because you know they will make very wise decisions for the shareholders and won't take stupid risks or make rosy projections (in fact they will probably always be over-pessimistic). I would compare the quality of FSLR's management to Apple's (AAPL) management, and as you probably know, only very few in the market understand that Apple always has lowballed and they often get hit by their lowball projections. First Solar Inc is pretty much in the same class. So take advantage of those great gift pullbacks and thank the CEO and CFO for being over conservative, it offers great long term opportunity for wise investor.

Disclosure : My fund is beginning a long position on FSLR and some other solar stock.

Comments

[Gregory Pepin:]

Once again, i think people should focus on cost per watt (which include the conversion rate in it) you will see that FSLR has a huge advantage today.


On Aug 06 11:10 PM TheDetective wrote:

> I agree with Cynnatalie2000 (what a complicated pseudonym fella!)
> in regards to FSLR's technology.. it seems that at least one Chinese
> competitor is right on target to become the cost leader in poly technology
> with their new plants. If that occurs, they will be able to MATCH
> and even improve Thin-film's current cost.. not only that, they would
> do so with a better technology, since the conversion rate from poly
> panels is more effective. How would this LIKELY scenario play out
> for FSLR's future margins? I don't doubt that FSLR has top management
> and excellent execution, however there's much you can do against
> better technology.. I'm not sure if the conversion rate of thin-film
> can be somehow improved with further R&D to compete with poly
> once they reach cost-parity.

Aug 07 04:54 AM

[Gregory Pepin:]

So if i understand well the technical side of the stock on the short term (once again it is short term as the long term fundamental is great so far). It could drop to 130 if the stock doesn t rebound today.
They were a spike in volume around the resistance to force the stock to go below. I guess the odds are clearly in favor of a quick drop before a rebound. It makes it an even more interesting pick for the long term


On Aug 07 12:22 AM J N King wrote:

> After today's stock action, I'm convinced FSLR is going significantly
> lower. The severe violation of the 200 day SMA today tells me, 130
> will arrive within a few trading days. Depending on volume and general
> market conditions, that level could be tested.
>
> On the other hand, if it closes above 145.89 tomorrow, there may
> be hope for price stabilization. My work, however, tells me that
> it is probably not in the cards.

Aug 07 04:55 AM

[Sol Invictus:]

Gregory -
Thanks for this article. Two comments:

1) One of your main assumption is that Chinese companies are producing at negative margins (you said "But we all know that Chinese solar companies won't be able to continue to leave on negative margin")

I would suggest that you take a look at the Q209 results of CSIQ released yesterday (GM 20%, net margin 15%) and wait for the release of YGE, TSL, SOLF and STP before sticking too heavily on this assumption.

Also, remember a few weeks ago, FSLR's CEO was flying to China for a site viste of Yingli's production plant...

2) You say "i think people should focus on cost per watt ". Cost per watt is a meaningless indicator. What counts is the LCOE (levelized cost of energy).

Regards.

Aug 07 07:02 AM

[Gregory Pepin:]

Sol invictus,
thanks for your great comment.
I would still like to add this :
-Some chinese company are in positive territory in term of GM but i have some doubt in their earning. Their margin of action is lower then it looks like on the paper. I don't think they can continue to drive down prices. FSLR is producing in Malaysia so they have a great labor cost, probably similar to chinese company. My assumption was a little bit aggressive. I think i should better say : the margin of price negociation is far higher for FSLR and the process of price dumping won't be permanent in Chinese Solar company. In addition to that, i would take a more cautious approach on Chinese Solar company number. The only company i fully trust is SOLF because they have been always very prudent and straight about the crisis effect.
- I agree with with you for LCOE but as far as i know FSLR is still at the top.

Aug 07 07:33 AM

[Sol Invictus:]

Thanks for your reply. I agree with your comments.
Bonne fin d'après-midi.

Aug 07 08:20 AM

[Perry B:]

good update and reviews

Aug 07 09:26 AM

[Fred W:]

Selling at a loss is the Chinese model that ALL solar manufacturers should have known was coming--when Si was in short supply they played nice. No more Mr. Niceguy.
The Chinese government will do what ever it takes to continue Chinese solar firms' growth--JOBS keep idle hands from protesting.
Long Term: FSLR still faces a huge problem with material supply--its own success will drive up raw Cad + Tel which are currently part of the "extras" found when mining Copper. New Cu mining methods that are rapidly being adopted DO NOT produce these "extras".
FSLR's recycling program is too far out to help.

Aug 07 10:42 AM

[J N King:]

With the bullish employment report, the market is looking pretty good. FSLR is flirting with that 200 day SMA. Yahoo shows that sometime today it was above 145.89. Again, a close above that line would be bullish, below, hello 130, IMO.


On Aug 07 04:55 AM Gregory Pepin wrote:

> So if i understand well the technical side of the stock on the short
> term (once again it is short term as the long term fundamental is
> great so far). It could drop to 130 if the stock doesn t rebound
> today.
> They were a spike in volume around the resistance to force the stock
> to go below. I guess the odds are clearly in favor of a quick drop
> before a rebound. It makes it an even more interesting pick for the
> long term

Aug 07 11:19 AM

[J N King:]

It's going to be a horserace to see which direction FSLR will be headed. Stay tuned.

Aug 07 02:27 PM

[Jack Yetiv:]

I respectfully disagree with the author and quite a few of the commenters. With poly at $35/kg, and assuming 5 g of poly per watt, the poly cost in a panel is 17 cents/watt--an almost irrelevant cost, and probably equal to the Cd and Te that FSLR puts in its panels.

So low-cost poly DOES essentially kill FSLR's "supposed" cost advantage. As an aside, Si is one of the most abundant elements on earth, and on a longterm basis, there is no reason for poly to cost $35/kg, especially as manufacturing processes to make poly become more efficient, given that the raw material to make it is pretty cheap.

I use the term "supposed" for a reason. Assume that FSLR produces panels with 10% efficiency, and its competitors 20% (SPWRA produces 22% panels today, the Chinese fabs are at 18-19%). Even assuming FSLR's Cd/Te costs were lower than the poly costs, FSLR MUST BUILD TWO PANELS to generate the same amount of power as ONE doubly-efficient poly panel. The aluminum, glass, fabrication, etc cost of the second panel must also be taken into account. Also, if high-efficiency poly panels are put on trackers, FSLR's cost "advantage" becomes even more spurious.

Finally, FSLR needs essentially twice as much real estate to generate the same amount of power as a field of poly-based panels (almost three times as much if the panels are put on trackers). That real estate does not come free--regardless of whether it is land in the Nevada desert or rooftops.

Taking all of these factors into account, I believe that FSLR does NOT deserve a higher forward PE than the likes of TSL, CSIQ, STP and SPWRA.

Jack Yetiv

Aug 08 03:48 AM

[Camden:]

Excellent article and some excellent replies. I think there valid argruments to be made on both sides. Whether or not FSLR is currently a good investment will depend on several factors mentioned above and some others, including:
1. It's ability to keep lowering it's cost/watt.
2. It's ability to maintain it's margins
3. How fast demand picks up for the solar industry as a whole
4. How fast the cost of producing polysilicon decreases
5. If the supply of polysilicon can keep up with demand (if it outpaces demand the price will fall to about production cost and stay there until demand picks up dramtically
6. The advancement of competing technologies
7. Passage of government legislation

My guess is that First Solar is likely to see it's margins compress as competition heats up. That will likely cause further PE compression. Earnings may increase without much increase in stock price. I've been invested in FSLR for most of the past three years and it's been a good ride. I suspect they will stay the leader (in terms of profits) for at least another two years due to long term contracts already in place if nothing else. Competitors have a LONG way to go to catch up. I'd also guess the future holds MUCH less annual stock price appreciation going forward. My stock position has been cut 75%. I need to see how this current situation plays out over the coming year before taking what I consider to be a "full" position again.

Aug 08 03:42 PM

[Gregory Pepin:]

I would like to point out some elements :
- I don't see poly price at 35$/kg over the long term. I still believe that 75-150$ range is more realistic.
- Concerning FSLR panel, i agree with you it needs more space but the most profitable project are the big one (that has the "real estate" space) and not the small project. And FSLR is a leader their. You have to add around 20c of cost intallation per watt on FSLR panel. Even by including that, they still have a solid advantage.
- Surprisingly, FSLR is also a leader in the residential market in front of ESLR (based on solarcity market only).

I do believe that FSLR deserve a higher P/E for many reason : Stronger balance sheet / Strong Backlog / Best cost structure in the business / Best market network and customer network / Best Management.
I also agree that Poly company has a too low P/E.


On Aug 08 03:48 AM Jack Yetiv wrote:

> I respectfully disagree with the author and quite a few of the commenters.
> With poly at $35/kg, and assuming 5 g of poly per watt, the poly
> cost in a panel is 17 cents/watt--an almost irrelevant cost, and
> probably equal to the Cd and Te that FSLR puts in its panels.
>
> So low-cost poly DOES essentially kill FSLR's "supposed" cost advantage.
> As an aside, Si is one of the most abundant elements on earth, and
> on a longterm basis, there is no reason for poly to cost $35/kg,
> especially as manufacturing processes to make poly become more efficient,
> given that the raw material to make it is pretty cheap.
>
> I use the term "supposed" for a reason. Assume that FSLR produces
> panels with 10% efficiency, and its competitors 20% (SPWRA produces
> 22% panels today, the Chinese fabs are at 18-19%). Even assuming
> FSLR's Cd/Te costs were lower than the poly costs, FSLR MUST BUILD
> TWO PANELS to generate the same amount of power as ONE doubly-efficient
> poly panel. The aluminum, glass, fabrication, etc cost of the second
> panel must also be taken into account. Also, if high-efficiency
> poly panels are put on trackers, FSLR's cost "advantage" becomes
> even more spurious.
>
> Finally, FSLR needs essentially twice as much real estate to generate
> the same amount of power as a field of poly-based panels (almost
> three times as much if the panels are put on trackers). That real
> estate does not come free--regardless of whether it is land in the
> Nevada desert or rooftops.
>
> Taking all of these factors into account, I believe that FSLR does
> NOT deserve a higher forward PE than the likes of TSL, CSIQ, STP
> and SPWRA.
>
> Jack Yetiv

Aug 10 07:08 AM

[Gregory Pepin:]

In order to complete my answer to Jack, if you look at the presentation of ESLR to analyst (available on www.evergreensolar.com.../ (PRESENTATION)) if you look at the slide 12. They describe the Wafer cost. We all know that Evergreen Solar has the best wafer technology (in term of cost structure). (That is aside of the quality of their management or whatever else, i'm purely talking in term of cost structure and expense to produce a wafer). They target a wafer price (if silicon is at 50$/kg) of 0,29$ for them and 0,50$ for the best of breed (the difference comes from the String ribbon technology that owns ESLR). And based on this projection they expect in 2012 a price of 1$/w in China (with a labor cost that will be close to other business like YGE and the difference in labor cost would probably be offset by the cost advantage for their wafer). So if you take the entire cost structure, the projection of 1$/w sounds realisitic by 2012 and right now FSLR is already below 80c and project to be below 70c. So i do believe that FSLR will still have a major cost advantage with their technology.

The projection cost (and the structure of the panel cost give by ESLR) is interesting to look. Even if you like or not their management it is according to me a very interesting projection over 2012.

Aug 10 07:17 AM

[Gregory Pepin:]

Good way to look at FSLR investment.

Just wanted to say, i think solar demand will strongly pick up when the credit market will be fully recovered (thx to stimulus etc and this environment invesmtent mind that is opening up now)


On Aug 08 03:42 PM Camden wrote:

> Excellent article and some excellent replies. I think there valid
> argruments to be made on both sides. Whether or not FSLR is currently
> a good investment will depend on several factors mentioned above
> and some others, including:
> 1. It's ability to keep lowering it's cost/watt.
> 2. It's ability to maintain it's margins
> 3. How fast demand picks up for the solar industry as a whole
> 4. How fast the cost of producing polysilicon decreases
> 5. If the supply of polysilicon can keep up with demand (if it outpaces
> demand the price will fall to about production cost and stay there
> until demand picks up dramtically
> 6. The advancement of competing technologies
> 7. Passage of government legislation
>
> My guess is that First Solar is likely to see it's margins compress
> as competition heats up. That will likely cause further PE compression.
> Earnings may increase without much increase in stock price. I've
> been invested in FSLR for most of the past three years and it's been
> a good ride. I suspect they will stay the leader (in terms of profits)
> for at least another two years due to long term contracts already
> in place if nothing else. Competitors have a LONG way to go to catch
> up. I'd also guess the future holds MUCH less annual stock price
> appreciation going forward. My stock position has been cut 75%. I
> need to see how this current situation plays out over the coming
> year before taking what I consider to be a "full" position again.

Aug 10 07:18 AM

[Gregory Pepin:]

JN King,
any update on the technical side with the bounce of friday?


On Aug 07 11:19 AM J N King wrote:

> With the bullish employment report, the market is looking pretty
> good. FSLR is flirting with that 200 day SMA. Yahoo shows that sometime
> today it was above 145.89. Again, a close above that line would be
> bullish, below, hello 130, IMO.

Aug 10 07:19 AM

[J N King:]

The current price is above the 200 day, but in tech analysis, the amount it's up, could be the width of a pencil mark on a chart. Let's see how the day ends. Above 146+/- a few cents and I could become a believer.


On Aug 10 07:19 AM Gregory Pepin wrote:

> JN King,
> any update on the technical side with the bounce of friday?

Aug 10 12:59 PM

[J N King:]

Well, it closed well above the 200 day SMA. The only problem I see is that the volume, compared to other penetrations of the 200 over the last 6-8 months, is 35-45% lower than before. Based on that, I'm still calling for lower prices near term. If I'm wrong, there is serious resistance @ the 158-160 area, IMO.


On Aug 10 12:59 PM J N King wrote:

> The current price is above the 200 day, but in tech analysis, the
> amount it's up, could be the width of a pencil mark on a chart. Let's
> see how the day ends. Above 146+/- a few cents and I could become
> a believer.

Aug 10 04:01 PM

[J N King:]

With today's market action (up) and the disappointing price action of FSLR (down), I would have to say the tech analysis looks correct for lower prices on this stock. The support looks fairly good in the 130 area. If that gets violated, then I'll take a second look to see where this stock might be headed, IMO.

Aug 12 05:38 PM

[J N King:]

Looking @ the chart today, if FSLR closes below $130+/- $1, I see the next price level around $100, IMO. I'll keep current near term for those that care, lol.

Aug 17 02:58 PM

[J N King:]

Now that FSLR has cracked the 130 area with the downgrade from Jefferies, if it doesn't hold here, the next area of support is around 105, IMO. If you are long, I would suggest purchase of 1-2 month puts. If you are looking to acquire more, wait until next month, again, IMO.

Aug 21 11:40 AM