Over the past 12 months the price of oil has risen 9.3% and that of natural gas has gone down by 41% while consumption of energy is generally going up with an increase in world population and purchasing power especially in emerging markets. With energy prices so volatile and dependent on a variety of factors that we cannot control, I believe that solar power is an alternative that has a future and First Solar (FSLR) is a good bet. I particularly like First Solar because it has a global footprint, its process of making solar panels has less stages because it uses tellurium in its solar cells which is also concentrated in the U.S., Japan, Canada and Peru, all friendly places, and the company is transitioning from a technology oriented one to an industrial company which makes its products more efficiently. Finally, at current valuation levels, the stock is undervalued compared to competitors and it might be a takeover target.
First Solar has 86.5 million shares outstanding, a market capitalization of about $2.5 billion and an enterprise value of $2.5 billion as both cash and long-term debt are about the same at about $650 million. Its inventory at the end of 2011 was $530 million compared to $200 million at the end of 2010 underscoring the glut of solar panels and the strong price competition in the industry. First Solar has a capacity for 2012 in the amount of 2.5 gigawatts but expects to produce around 1.5 - 1.8 gigawatts thus having a utilization of 60%-72% of its factories. The price per watt is estimated to be $0.74 per watt (including the cost of underutilization), virtually unchanged from the 2011 cost of $0.73. I think it is a big positive that the company is trying to reduce the costs of its plant underutilization and improve its module efficiency which is currently at 12.7%. Also, 2012 is a pivotal year as several projects that were started earlier are reaching levels where they will start generating cash flow instead of using working capital.
Valuation and Competition
First Solar is currently undervalued as it has a price to sales ratio of 0.9 compared to 1.6 for the industry and 1.3 for the S&P 500. Its price to book value ratio is also attractive at 0.70 compared to 4 and 4.6 for the industry and S&P 500, respectively. The past year was a difficult year as European countries started to reduce government subsidies and also because in the U.S. the solar panel manufacturers were rocked by the sudden bankruptcy of Solyndra a few months after securing loan guarantees of hundreds of millions of dollars from the Federal government.
For the full 2011, First Solar GAAP earnings per share were ($0.45) but excluding warranty expenses, goodwill write-offs, and restructuring charges it earned $6.01 per share in 2011, giving the company a price to earnings ratio of about 5. For 2012, the company estimates that it will earn $3.75 - $4.25 per share for a 2012 price to earnings ratio of 7.5 while the industry and S&P 500 price to earnings ratio is 16.3 and 15, respectively.
Most of First Solar competitors are based in China, including Suntech Power (STP), LDK Solar (LDK), and Yingli Green Energy (YGE) and only SunPower (SPWR) is based in the U.S. Chinese companies are able to borrow from their government related banks and invest in the capital intensive projects and also they have lower labor costs. Regardless, First Solar has the second highest level of sales in the amount of $2.7 billion for 2011 ahead of the sales of $2.6 billion, $2.3 billion and $2.3 billion for LDK, Yingli, and SunPower but behind Suntech sales of $3.1 billion. First Solar also has the highest price to sales ratio of 0.9 compared to a price to sales ratio of 0.2, 0.3, 0.3, and 0.5 for Suntech, LDK, Yingli, and SunPower. I believe that the premium in price to sales ratio for First Solar is that most Chinese companies cater to both commercial and retail customers, while First Solar builds high-scale wind factories that it continues to manage and operate even after they are sold.
In addition to this, First Solar is the only company which uses cadmium telluride to produce its solar panels which is much cheaper. Thus it costs First Solar $0.73 to produce a watt which is the lowest rate compared to its competitors. The drawback is that its products have the lowest efficiency at around 13% compared to around 20% for the silicon based solar panels. While they take more light to produce the same electricity, First Solar panels have an advantage that they can produce electricity at lower light levels giving more stable and predictable flow of electricity, which utility companies generally prefer.
The electricity produced by solar cells without including any government subsidies is still more expensive than that from on-shore wind farms or gas powered plants. First Solar is the cost leader and also has access to markets in Europe and Asia (its main manufacturing facilities are Germany and Malaysia). By focusing on solar farms with large capacities, First Solar is the most prepared of all firms to thrive on its own without these government subsidies. It is a lot more efficient to distribute the electricity from large solar power plants than from panels installed on individual buildings which most of FirstSolar's competitors currently do.
On September of 2011 First Solar announced that it closed on the sale of two solar power projects one for 550 megawatts and the second for 230 megawatts. The Department of Energy backed the loans for the purchase of the two projects with guarantees for $1.46 billion and $646 million, respectively. It is not clear when the government backing of this type of loans will end but I project it will be soon, sometime in the next few years. At this point it makes sense for First Solar to be owned by a larger owner to finance its capital intensive projects which have 25 year of estimated lives. An acquirer could be a private equity firm or a large industrial conglomerate. Any take out should be at a significant premium to current prices as 60% of SunPower recently changed ownership for $1.37 billion which values the company at $2.3 billion. However, First Solar should be worth more than that as it has an earnings before interest, tax and depreciation margin of about 6% compared to a negative 17% for SunPower. Indeed, an article published at the end of 2011 on Bloomberg speculated that First Solar is a likely takeover target for a number of buyers including its current largest shareholder, the Walton family, better known in the retailing world. A reason for a deal not going through could be potential liabilities with acquiring a company which works with cadmium telluride, which is considered carcinogenic in the EU.
First Solar is attractively valued and is a leader in the solar power panel manufacturing. While 2011 was a rocky year, many of the company's large projects already have buyers and will come to fruition in the next several years. The worst is definitely behind and now the company should be able to reward shareholders even without government subsidies for the industry while meeting the demand for more and greener energy.