First Solar, Inc. (NASDAQ:FSLR) is currently providing investors a great value opportunity with the potential for long term growth. While we expect a shake out to occur within the solar industry over the course of next year due to a softening in U.S. utility scale demand and international overcapacity of modules, we believe FSLR is by far the best positioned company to handle a cyclical earnings trough in 2017. Management has built a best in breed competitor with a strong balance sheet that values the company at a little over $16 when only realizing cash and short term investments. Furthermore, the company is well positioned with a pipeline of superior technology and an established a runway for long term growth to enable a return to margin expansion through 2018 and beyond. At the current price, First Solar provides a significant margin of safety and is slightly undervalued with even the most bearish of assumptions materializing. Should our most bullish valuation prevail, we believe FSLR has the potential to be fully valued at $67.65 on a multi-year time frame.
Company Overview
First Solar, Inc. operates as a global provider of solar energy solutions. The company was founded in 1999 (as First Solar Holdings, Inc.) and has a major presence as both a thin-film solar manufacturer as well as a vertically integrated solar project developer. Since inception, FSLR has sold over 13.5 of Gigawatts of power and manufactured more than 155 million modules. Las year First Solar generated $3.6 billion in revenue through its two business segments: components and systems.
The components business involves the design, manufacture and sale of solar modules which convert sunlight into electricity. First Solar's modules are unique in that they are primarily manufactured from Cadmium Telluride (CdTe). For a few years, the firm did hedge its technology with the industry standard crystalline silicon modules through the acquisition of TetraSun in 2013. However, it was announced this past July that FSLR is halting production and development of silicon modules and shifting its focus back to Cadmium Telluride where they are the only major manufacturer in the United States. The firm currently has manufacturing facilities for solar modules in Perrysburg, Ohio and Kulim Malaysia. Year to date, the components business accounted for approximately 42% of net sales.
The systems business is the larger of the two and can be divided into three services: Project Development, Engineering, Procurement & Construction, and Operations & Maintenance (O&M). Major clients consist of utilities, independent power producers, and commercial and industrial companies, and other system owners. These customers may elect to purchase a completed fully integrated system or any combination of the above listed services. Apple Inc., NextEra Energy, Inc., and Southern Company are just a few examples of corporations that First Solar has partnered with in the past. Year to date, the systems business accounted for approximately 58% of net sales.
While the majority of revenues were generated domestically last year (about 87%), First Solar's new CEO, Mark Widmar, is looking to grow the firm's international footprint. Widmar had served as the firm's Chief Financial Officer since April 2011, when he joined the firm, until June 30th this year. He replaced Jim Hughes who had been CEO since May 2012.
Investment Thesis
On December 18th, 2015 the United States government extended the 30% Investment Tax Credit for the solar industry through 2019 for both residential and commercial projects. While we view this as a positive long term development, it can simultaneously be perceived as a present headwind. As the graph below shows, utility project deployment is set to have a significant decline next year before it returns to steady growth. The reasoning is simple: the most urgent projects were booked by 2016 due to the uncertainty in the continuation of the ITC. Therefore, there is no pent up demand from large utility companies projected to hit the market in 2017.
Source: Solar Energy Industries Association
The market, being forward looking, has devalued First Solar over 50% in about the last 6 months from a 52 week high of 74.29 in March to a multi-year low of 33.74 just last week. Sentiment has soured on the street with multiple sell side down grades and price target cuts. There are concerns that the modules business is oversupplied and commoditized and will face declining margins going forward. Moreover, this is happening at a time when management needs to transition the business to be more components focused to offset the decline of the historically larger systems revenue model.
While these worries may be warranted to some extent, we believe the market is beginning to present a significant opportunity to the astute value investor with multi year time frame and contrarian mindset. Our qualitative argument for First Solar is threefold: 1) Unique Technology with a Promising Pipeline 2) Domestic and International Growth Potential 3) Prepared for Industry Consolidation.
Unique Technology with a Promising Pipeline
First Solar, Inc. invests more heavily in R&D than any of its competitors. The firm is no longer manufacturing crystalline silicon modules and has now recommitted itself to the CdTe technology which made it unique in the first place. There have been significant developments reported this year from both a cost and an efficiency perspective.
For the past 3 years, First Solar has been trailing behind Trina Solar Ltd. (TSL), China's top polysilicon producer when it comes to manufacturing costs. At the moment, this dynamic has changed with FSLR regaining the lead at 40 cents a watt while TSL is hoping for 43 cents a watt by year end. Furthermore, First Solar has the ability to widen the margin over the next 3 years with potential to produce at 25 cents a watt while the path lower for the polysilicon competitor is much more unclear at this point.
Turning to efficiency, the current module in production in these Series 4 which has a conversion rate as high as 16.8%. While most silicon-based panels currently have an efficiency between 16-18%, we believe First Solar's pipeline is what makes it so compelling. The Series 5 module is expected to launch by the end of 2017 and the Series 6 is expected to launch in 2019. With this road map, management is hoping for real word efficiency of 19% in 3 years. In the lab, First Solar continues to make progress setting a new efficiency record of 22.1% for cadmium telluride cells. We also think the investment to stick with CadTel will pay dividends in the long run as its theoretical efficiency is around 30% while multi-crystalline may already be reaching its practical efficiency limit.
Domestic and International Growth Potential
Management believes over the long run that there is 24 Gigawatt worldwide growth opportunity for First Solar. Putting that in perspective, this amounts to almost twice the amount the company has sold since inception. To meet this ambitious goal will take a significant amount of growth from the U.S. Market and the International Market, particularly Middle East and India.
Due to management's lack of guidance for 2017, we believe the market has priced in a large drop for domestic large scale utility projects for next year. While this may occur, we do believe there are a few potential upside scenarios that have ability to either soften the decline in the utility business or offset it with growth elsewhere. Most prediction models have Hillary Clinton as favored to win the U.S. Presidency in November. She has been on record calling for a 700 percent increase in solar energy by the end of her first term. This is most likely political rhetoric, but we do view a continuation in a Democratic presidency as a long term positive, especially if First Solar can win some lucrative infrastructure deals that are put forward. Though it may not materialize right away, we also believe the market is not pricing in the potential for long term growth in Community Solar solutions. On the last conference call, CEO Mark Widmar was "encouraged by the increasing demand" and "a third-party research firm recently estimated that Community Solar's addressable market is more than seven times as large as rooftop solar."
First Solar is also well positioned to grow its international footprint going forward in Middle East and India. The primary reason is that First Solar's CdTe modules perform better than all the competitors in hot and humid conditions. The company is expected to be the leading provider of solar solutions to the Middle East in 2017. It has business relationships in Dubai, Jordan, and Egypt, with plans to expand to neighboring countries. Likewise, India has committed to increase its solar power to 100 GW by 2022. The country presently has over 8 GW installed and First Solar accounts for at least 1 GW of that output. While FSLR is estimated to account for 10-15% of the market share today, we believe with the proper execution those estimates can eventually be take up to 15-20%. A few weeks ago, the WTO made a favorable ruling for U.S. solar companies acknowledging that New Delhi had discriminated against U.S. solar imports.
Prepared for Industry Consolidation
Our last point stems from the idea that we think industry as a whole is ripe for a shakeout in the next 12 - 18 months and First Solar is prepared to survive an uncertain 2017 and thrive beyond it. We applaud management's recent restructuring actions, including the shutdown of the TetraSun silicon product line, which will contribute towards the expected $60-80 million in total annualized savings. This will further pad an already cash rich balance sheet, giving management plenty of flexibility to navigate through a period of uncertainty.
A supply glut in the global solar PV module is expected to persist into 2017 as Chinese manufacturers continue to flood the market. These producers continue to enjoy low input costs as the price of polysilicon continues to remain at the low end of its price range. However, polysilicon has been a very volatile commodity with prices ranging anywhere from $14 - $475 in the last decade. If polysilicon pricing begins to turn back up this may spell trouble for weaker players that are either not profitable or have very thin operating margins. FSLR's thin-film panels use about 98 percent less semiconducting material and since they are made from CadTel, are insulated from the polysilicon pricing cycle.
First Solar has remained profitable on an annual basis since 2007, while domestic competitors like SolarCity Corp. (SCTY) and SunPower Corp (SPWR) are not profitable in this current environment. Finally, management has disclosed that when the Series 5 is released next year it "will significantly broaden the spectrum of third-party structures and track technologies available for use with our modules without requiring First Solar specific components." This is expected to reduce both channel conflicts and the engineering, procurement & construction workforce needed going forward.
Financials and Valuation
In order to gain a deeper quantitative understanding of First Solar, we have valued the company from multiple perspectives. First, we analyzed several financial metrics of the firm relative to its peers (as compiled by Bloomberg Intelligence) in the global solar industry. Second, we created a simple multi-factor model with four fundamental ratios and evaluated the present value against its 5 year average. Finally, we calculated the intrinsic value of FSLR via the "Graham Number" utilizing current tangible book value and 3 different future EPS assumptions.
First Solar, Inc. Comparison to Industry
Company | Ticker / Country | Market Cap (USD) | EV / T12M EBIT | Total Debt / Total Equity | Net Sales T12M |
First Solar Inc. | FSLR / US | 4.00B | 4.45 | 4.02% | 4.00B |
Canadian Solar Inc. | CSIQ / US | 811.02M | 11.53 | 260.32% | 3.50B |
GCL-Poly Energy Holdings Ltd. | 3800 / HK | 2.47B | 9.55 | 180.33% | 3.19B |
Hanwha Q Cells Co. Ltd. - ADR | HQCL / US | 985.51M | 9.75 | 303.04% | 2.28B |
Hareon Solar Technology Co. Ltd. - ADR | 600401 / CH | 1.63B | 43.59 | 140.21% | 1.02B |
JA Solar Holding Co., Ltd. - ADR | JASO / US | 291.13M | 6.53 | 97.89% | 2.48B |
JinkoSolar Holding Co., Ltd. - ADR | JKS / US | 517.58M | 9.07 | 231.05% | 3.35B |
LDK Solar Co., Ltd. - ADR | LDKYQ / US | 5.30M | N/A | N/A | 598.25M |
Motech Industries Inc. | 6244 / TT | 494.50M | 8.15 | 65.21% | 1.04B |
Neo Solar Power Corp. | 3576 / TT | 485.66M | N/A | 59.84% | 707.43M |
REC Silicon ASA | REC / NO | 344.23M | N/A | 19.34% | 302.30M |
Renesola Ltd. - ADR | SOL / US | 104.97M | 16.45 | 637.99% | 1.18B |
Shanghai Aerospace Automobile - ADR | 600151 / CH | 2.25B | 77.57 | 142.85% | 787.24M |
Shunfeng International Clean | 1165 / HK | 511.87M | 18.05 | 156.80% | 1.26B |
SolarCity Corp | SCTY / US | 1.97B | N/A | 178.81% | 537.69M |
SolarWorld AG | SWVK / GR | 52.12M | N/A | 206.54% | 974.19M |
SunEdison Inc. | SUNEQ / US | 18.51M | N/A | 255.24% | 1.86B |
SunPower Corp. | SPWR / US | 1.25B | N/A | 141.53% | 1.56B |
Trina Solar Ltd. - ADR | TSL / US | 949.62M | 8.39 | 179.32% | 3.53B |
Yingli Green Energy Holding Ltd. -ADR | YGE / US | 69.80M | N/A | N/A | 1.43B |
Average | 960.39M | 18.59 | 181.13% | 1.78B |
(Source: Bloomberg)
From the data above, it should be clear that FSLR screens well across the board. It is the cheapest company based on EV / EBIT and generates the most revenue while employing the least leverage. We also view the facts that the company is headquartered in the U.S. and currently has the largest market capitalization as positives.
First Solar, Inc. Current Valuation vs. 5 Year Average
P /E | 5.23 | P / B | 0.69 | P / S | 0.99 | EV / EBITDA | 3.40 |
P / E 5 Yr Avg. | 11.11 | P / B 5 Yr Avg. | 1.01 | P / S 5 Yr Avg. | 1.49 | EV / EBITDA 5 Yr Avg. | 4.91 |
(Source: Bloomberg)
The table above demonstrates that First Solar's current valuation is significantly lower than its average valuation over the last five years on all four metrics. If we calculate the percentage difference between the current ratio to the 5 year average for each ratio and weight each equally, our multifactor models tells us that FSLR, at $39.08 per share, is trading at 37.23% discount to its mean value in the past.
Employing this analysis gives us a price target for FSLR of $53.63.
First Solar Intrinsic Valuation - Graham Number
The Graham Number is calculated as follows:
Utilizing the latest filing, we have calculated First Solar's current tangible book value to be 55.27. Below are Bloomberg's adjusted EPS estimates from 2011 - 2020:
Year | FY 2011 | FY 2012 | FY 2013 | FY 2014 | FY 2015 |
Adjusted EPS | 5.83 | 4.62 | 4.45 | 2.61 | 4.31 |
Year | FY 2016 Est. | FY 2017 Est. | FY 2018 Est. | FY 2019 Est. | FY 2020 Est. |
Adjusted EPS Estimate | 4.37 | 2.29 | 3.17 | 3.81 | 4.78 |
(Source: Bloomberg)
As the data shows, the consensus among analysts is that next year's EPS for First Solar is set to be the lowest of the decade, at $2.29, before growing again. In fact, the lowest EPS estimate on the street for 2017 is $1.30. For a smoother long term estimate, we arrive at $3.68 per share if we take the average consensus estimate from 2016 - 2020. Presented below are those three EPS assumptions for FSLR and their calculated Graham numbers listed adjacent:
EPS Assumption | Graham Number |
1.30 | 40.21 |
2.29 | 53.36 |
3.68 | 67.65 |
Given that FSLR is currently trading below even the most bearish forward estimate of 2017, in what may be a year in which a decade long earnings trough occurs, we believe a sufficient margin of safety is being offered. Should even a moderately bullish narrative begin to take shape, we believe there is potential for double digit upside in FSLR over the next several years.
Risk Factors
- Failure to increase bookings for large scale utility projects.
- Delays in the release of Series 5 and Series 6 modules.
- Unable to penetrate international markets further.
- Crystalline silicon modules have a major efficiency breakthrough and surpass CdTe again.
- Competitors regain cost advantage in producing panels.
- Consolidation of solar market does not materialize and oversupply causes margins to compress further.
