Why First Solar Will Continue To Dominate In The Solar Industry

| About: First Solar, (FSLR)

Summary

First Solar's latest efficiency record for cadmium telluride (CdTe) thin-film solar PV stands at 22.1%, delivering on its promise to hit a 22 percent research cell by 2015.

CdTe and other thin film modules offer a higher yield per watt then standard crystalline silicon, particularly in hot climates, making them increasingly competitive.

First Solar is producing panels for as little as 40 cents a watt. In 2019, First Solar's module costs could be as low as 25 cents a watt.

Average fleet efficiency is improving 3 times faster than mc-Si.

First Solar (NASDAQ:FSLR) is continuing to make impressive strides on its technology road map. Due to the lack of a guidance for 2017, the stock declined around 16% off its 52-weeks high. This development has resulted in an attractive entry point. The conservative growth plans of the company are seen as a negative by some, I would say that the conservative nature of First Solar is extremely positive, considering the capital-intensive nature of the Devco and the recent disastrous collapse of SunEdison (SUNE).

Looking at the chart, the stock has tested support around $60, providing for an attractive entry point for long-term investors in one of the most well-run solar companies.

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Source: Finviz.

Investment thesis

First Solar's gains on the efficiency-front are impressive, reaching 22.1% in a laboratory cell this year, an improvement that eventually will be applied at its plants. First Solar uses a different technology than multi-crystalline polysilicon, a thin film of cadmium-telluride, which has a lot more room to improve compared to multicrystalline silicon. The theoretical peak is at around 30%. The semiconductor material used in First Solar's thin film modules has the highest theoretical efficiency of any PV material known today, significantly higher than crystalline silicon. The efficiency improvements, combined with the lowest inherent manufacturing costs, makes First Solar an increasingly competitive player.

Source: Company website.

The curve shown above is known as the S-Q limit, it illustrates the thermodynamic efficiency limit for single-junction conversion of the solar spectrum. The semiconductor material utilized in First Solar's thin film module technology is sourced from byproducts of the zinc and copper industries. Cadmium is a waste byproduct of zinc refining, and tellurium a byproduct of copper refining, and are together formed into a stable CdTe compound. Recently there have been 5 world records in efficiency in CdTe technology, compared with relatively slow progress in single crystal and multicrystalline silicon. The existing gap between First Solar's top research cell of 22.1% and the theoretical limit of 30% provides tremendous opportunity for improvement.

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Source: First Solar investor presentation.

As an example for the continuing progress on the efficiency front of CdTe solar cells, I would like to take a short side path to recent developments in CdTe technology. Researchers recently improved the maximum voltage available from a cadmium telluride (CdTe) solar cell, overcoming a practical limit that has been pursued for six decades and is key to further improving efficiency. The work was published in the Feb. 29 issue of Nature Energy.

Currently silicon solar cells represent around 90 percent of the solar cell market, but it will be very difficult to significantly reduce their manufacturing costs. As noted, CdTe solar cells offer a low-cost alternative to silicon solar cells. CdTe technology has the lowest carbon footprint in solar technology and performs better than silicon in real world conditions, including in hot, humid weather and under low light conditions. Until very recently however, CdTe cells haven't been as efficient as silicon cells.

One of the most important areas researchers are trying to improve CdTe technology, is the maximum voltage available from the solar cell, called open-circuit voltage. For the past 60 years, researchers haven't been able to surpass the 900 millivolts threshold, which for a long time was considered its practical limit. A research team from Washington State University improved cell voltage by shifting from a standard processing step using cadmium chloride. They placed a number of phosphorus atoms on tellurium lattice sites and then formed ideal interfaces between materials with different atomic spacing to complete the solar cell. The result was an improvement of the conductivity and carrier lifetime, enabling fabrication of CdTe solar cells with an open-circuit voltage, breaking the 1-volt barrier for the first time. According to the research team, the innovation establishes new research paths for solar cells to become more efficient, and provide electricity at a lower cost than fossil fuels. The team is arguing that silicon-based cells have almost hit their theoretical limit, but that there is significant room for efficiency improvements for CdTe technology.

In CdTe PV module manufacturing, three main process steps are used: first the deposition of semiconductor material, secondly the PV cell formation, and thirdly the final module assembly and test is performed. The product uses a large glass substrate vs. individual Si wafers and uses only 1-2% of the semiconductor material vs. Si. Another advantage is the relatively quick way of manufacturing, First Solar is known to produce one CdTe module in about 2.5 hours, which is very fast.

Source: First Solar CdTe Photovoltaic Technology: Environmental, Health and Safety Assessment.

Manufacturing costs

The CdTe technology also has one of the lowest inherent manufacturing costs. First Solar stopped providing updates on average module costs in 2013, however analysts' models are predicting First Solar's module costs could be as low as 25 cents a watt in 2019. According to Bloomberg, for the first time in three years, First Solar is making panels for less than China's biggest producer (Trina Solar). According to Jeffrey Osborne, a Cowen & Co analyst in New York:

The Chinese have hit a wall in terms of polysilicon costs and technology, there aren't a lot of levers left for them to pull and their labor costs are rising.

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Monocrystalline polysilicon comes close in its theoretical peak efficiency with 29%, however due to high costs, it is not widely used in mass-produced solar cells. Multicrystalline polysilicon, the most used type, is nearing its practical efficiency limit, Trina Solar (NYSE:TSL) holds the laboratory record with 21.3%.

For years, First Solar held a cost advantage over polysilicon products. First Solar's panels require less time, labor and energy to manufacture, it also uses less of the semiconductor materials, which was very costly in the take-off of the solar industry. Polysilicon costs have, however, seen a rapid decline to about $14 a kilogram now, from $475 in 2008. For a while, First Solar, lost its cost advantage vs. the Chinese panel producers. In a strategic shift, it focused on developing big power plants, insulating itself from direct competition with cheap Chinese producers.

Currently, First Solar is trying to reorient its business again, now that the economics of the business are shifting strongly back in favor of its thin film technology. The current sales mix consists of 70% out of developing big solar farms for utilities, the other 30% comes from providing panels, or modules, to other developers. First Solar is working towards a reversion of this ratio, according to CEO Jim Hughes:

''We're not de-emphasizing or downsizing our development business, we just think, as we look at growth, that opportunity is going to be module-only. The vast majority of our expansion will be modules''.

This shift is one of the reasons Hughes refused to issue guidance for earnings in 2017, resulting in a disappointed reaction of investors which led to a decline of the stock by 7.2%.

Energy density advantage

Besides the higher efficiency, panels from First Solar offer some other advantages; such as a better performance in high-temperature regions like the Middle East and India, two core growth regions of First Solar. The company estimates its products generate up to 11% more power per square meter than polysilicon.

These advantages include: a superior temperature coefficient with up to 2% more specific annual energy yield than C-Si, a better spectral response of up to 6% more specific annual energy yield than C-Si; in humid conditions and a better shading response of more than 1% than C-Si.

Click to enlargeSource: First Solar investor presentation.

As can be seen above, First Solar's highest energy density advantage consists of regions with higher than average humidity/temperature. This energy density advantage is most prevalent in regions with rapidly growing solar markets, such as India, the Middle East, Latin America and large parts of Africa:

Click to enlargeSource: First Solar investor presentation.

The company is constantly improving its technology road map. During the analyst day it introduced a medium voltage DC Plant Architecture (MVDC). Key benefits according to First Solar are:

- fewer components/reduced wiring
- higher plant efficiency
- reduced O&M
- robust grid capability

And maybe most importantly: ready for storage architecture. First Solar is expecting a commercial pilot in 2017 and the product launch in 2018.

Click to enlargeSource: First Solar investor presentation.

Financial performance

One of the things I like the most of First Solar is its conservative management team and its robust balance sheet, with a net cash balance of $1.5 billion at the end of 2015, and an expected net cash balance of $1.9 billion to $2.2 billion at the end of 2016. As a result, First Solar does not have the high-cost-of-capital problems that a lot of cash-strapped competitors have, the most notable example being SunEdison with its $725 million second lien secured term loan at an interest rate of LIBOR plus 10% in January this year.


Source: First Solar 2015 annual report.

The year 2015 was one of the strongest years of financial performance in First Solar's history. The company achieved record annual sales of $3.6 billion with earnings per share of $5.37, superior to guidance set in 2015.

In 2015, the company also took the step of retaining a partial ownership interest in several of its solar projects, through its joint launch of a yieldco together with SunPower (NASDAQ:SPWR): 8point3 Energy Partners (NASDAQ:CAFD). The launch of this yieldco provides a committed buyer of certain projects and provides a steady stream of future dividends to First Solar. What I like the most about this yieldco is its joint ownership with SunPower, providing a safety net against conflict of interest between the yieldco and its parent companies. Broader macroeconomic factors have adversely impacted yieldcos, in this light First Solar has been conservative in dropping assets to 8point3. Its initial portfolio includes interests in 432 MW of solar energy projects.

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The company's backlog and pipeline are increasing at a rapid rate:

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The conservative nature of First Solar is reflected in its continued ability to surprise on its EPS:

Quarter Estimate EPS Actual EPS Surprise Surprise (%)
Dec '14 0.76 1.89 1.13 148.68%
Mar '15 -0.29 -0.62 -0.33 -113.8%
Jun '15 0.36 0.93 0.57 158.3%
Sep '15 1.55 3.41 1.86 120%
Dec '15 0.77 1.60 0.83 107.8%
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Source: Yahoo Finance.

First Solar provided the following guidance for 2016:


Source: Company filings.

Looking at the company's history of beating estimates and often conservative guidance, I wouldn't be surprised if this happens again coming Wednesday, when First Solar is filing its Q1 results.

Valuation

For my valuation I use a bear and a bull case with varying EBITDA margins. For both scenarios, the mid-point of net sales is used ($4.0B). In my base scenario I use an EBTIDA margin of 15%, in my Bull scenario an EBITDA margin of 17%. Analysts expect an EBITDA margin of around 15%. My base and bull cases are provided below:

Base Bull
EBITDA 600 680
Multiple 10 10
EV 6,000 6,800
+Cash 2,000 2,200
-Debt 289 289
Total Equity 7,711 9,000
Shares Outstanding 102.21 102.21
Estimated Equity Per Share 75.4 88
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In millions

My base scenario results in an upside of 22.5% and my bull scenario in an upside of 43%.

Conclusion

There are a lot of reasons to like First Solar, the conservative management, its conservative balance sheet and consistent performance. I rate the stock as a buy on continued improvements on their technology road map and impressive financial performance.

Disclosure: I am/we are 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.

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