First Solar: Upside Momentum To Continue

Mar.30.14 | About: First Solar, (FSLR)

Summary

FSLR's strong fundamental trend (i.e. efficiency improvement and cost reduction) should ensure healthy organic growth.

Balance sheet strength provides significant capacity for future M&A which would drive incremental growth that has not been factored in.

Trading below peer average on EV/EBITDA basis, FSLR's valuation is inexpensive and the stock is a buy.

The share price of First Solar (NASDAQ:FSLR) has risen substantially by 154% over the past 12 months, compared to just an 18% return for S&P 500. In my view, there remains ample room for further price appreciation given the stock's inexpensive valuation and that the company is well poised for significant long-term growth which will be driven by technology advancement, cost reduction, and adjacent market expansion.

In the company's recent Analyst meeting, management provided their long-term vision on FSLR's CdTe technology. The technology's cell efficiency is expected to rise from 20% in 2014 to 25% in 2016. Given that the efficiency ratios for both multi-crystalline and mono crystal cells are currently at about 20% and 25%, respectively, which are close to their theoretical limits largely due to limited investments, it is believed that CdTe's cell efficiency would eventually surpass the efficiency of the two competing technologies. Management also expects system-wide efficiency to reach 19.5% by 2017, which is higher than previous target of 17.2%.

A key implication from the technology advancement is that the higher efficiency would improve FSLR's competitiveness in commercial and industrial ("C&I") end market. As a note, the C&I end market is projected to account for more than 45% of the total global solar market by 2016, a potential of which is more significant than the utility scale end market that FSLR currently generates a majority of its sales from. The company currently has identified 45 MW C&I opportunities and has already been short-listed for 15 MW potential projects. If management's technology advancement plan materializes, project opportunities in this space are likely to grow significantly.

Aside from the C&I market, FSLR would also be able to build a solid presence in the hybrid generation market, which generates power by leveraging solar and other fuel sources with a market potential of 635 GW. Management indicated that the company has identified 150 MW hybrid opportunities with 50 MW being short-listed.

Moreover, through system efficiency improvement and partnership with General Electric (NYSE:GE) for system incorporation, FSLR's total system cost is expected to decline to below $1 by 2017, representing at least a 36% reduction from $1.6 in 2013. In terms of financing cost, management indicated that debt market has been increasingly favoring the solar industry given its solid long-term growth prospects and steady cash flow streams and the positive sentiment has compressed yield spread, resulting in lower cost of capital. As such, the decrease in both FSLR's total system cost and cost of capital are expected to lower the company's levelized cost of energy ("LCOE") and there improve its competitiveness. I believe that the decreased cost of capital would also benefit the solar industry as it will effectively lower LCOE for solar projects and facilitate solar's competition with other power-generating sources.

FSLR continues to maintain a best-in-class balance sheet. As of December 31, 2013, the company has $1.8 billion in cash, representing 26% of current market capitalization. It only carries total debt of $0.2B, translating into a debt to capital ratio of just 4.8%. My view is that the balance sheet strength should provide FSLR ample financial capacity for project investments and also allow the company to attract financing at more favorable rates than many other solar competitors.

Despite the significant price run-up over the past 12 months, FSLR's valuation remains inexpensive on a relative basis. As some of FSLR's industry peers have not turned EPS positive, I believe forward EV/EBITDA multiple would bear a better comparability. The stock's 2015 forward EV/EBITDA multiple of 5.7x is modestly below peer average at 6.6x despite the fact that FSLR's 2015 consensus estimated EBITDA margin is well above its peer's average level (see chart below).

Click to enlarge

Some investors may have concern on the company's performance in 2016 as management guided an approximately flat revenue range compared to 2015 level ($3.8B to $4.5B) and a lower EPS range of $3.5-$5.0 per share from $4.5-$6.0 per share in 2015 given the fact that the company's legacy pipeline will be depleted by the end of 2015 and the guided 2016 performance is expected to be primarily driven by non-contracted volumes. In my opinion, market's fear is overdone as I believe the company is able to sustain its growth or at least achieve the high end of management's guided financial ranges based on the following reasons:

  1. As just mentioned, owing to management's continued effort to drive up efficiency rate and reduce total system cost, FSLR should achieve decent organic growth by expanding into adjacent markets such as C&I and hybrid generation.
  2. Another organic growth opportunity would be the entrance into unsubsidized utility scale market. Given that entering the unsubsidized market requires a low selling price, competition in this area is less fierce as many solar companies have not achieved sufficient cost advantage to break even. Owing to the industry-leading system cost structure and competitive expertise in utility scale solar business, I believe FSLR is well positioned to build a solid presence in the near future despite the fact that this would result in lower margin.
  3. In terms of incremental growth, I believe FSLR's balance strength should provide the company a substantial M&A capacity. Management guided $300M-$350M capex and $250M-$450M operating cash flow for 2014. Beyond that, the company expects to generate $300M-$600M in 2015 and $800M-$1,300M in 2016. The guidance implies that FSLR's free cash flow trajectory should remain net positive over the next 3 years, suggesting that the current $1.8B cash balance should be at least intact throughout the period. In addition, FSLR's total debt to capital ratio and total debt to EBITDA multiple are substantially below peer averages (see chart below). As such, an additional $2.2B debt taken by FSLR would raise the two leverage metrics to just 50% and 3.4x, which are still below the peer averages. This analysis means that FSLR should have the capacity to comfortably pursue M&A opportunities worth of at least $2B to $3B in the near future to drive incremental financial growth, which is not baked in the market's expectations.

In summary, FSLR is well poised for solid organic growth in the near term and the company would leverage its balance strength to drive incremental growth opportunities. As the valuation is inexpensive on a relative basis, investors are recommended to buy the shares now.

All charts are created by the author, and data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.

Disclosure: I am long FSLR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.