By Matthew Smith
First Solar (FSLR) has dropped precipitously over the past year. Despite this drop, First Solar is not a particularly attractive value buy. If you want exposure to private firms which depend on government subsidies, there are better trades in the for-profit education industry. On the other hand, there are better energy plays than First Solar to be found in the traditional oil and gas industry. Valero, for example, is trading at an attractive price, even after seeing a 36.5% increase in share price over the past 12 months. The company also offers a healthy dividend yield of 2.1%. Additionally, several countries, including the U.S., Italy, Germany and others, are looking at austerity measures to cut subsidies given to the solar energy industry. These developments could impact solar energy demand in a negative way. I believe there are better investment alternatives, and will detail this below.
Solar Industry Challenges
Investors interested in First Solar must ask if the solar industry can survive without government subsidies. The celebrated short seller Jim Chanos has been a vocal critic of the feasibility of wind and solar. A Forbes article from last year quoted Chanos as saying, "Wind and solar are not capable of being sufficient sources of power, they are not economically efficient." Chanos pointed to natural gas as a more economical alternative that beats solar and wind as a cheaper energy source. He argues that renewables are not competitive without government support.
These warnings are certainly justified. According to First Solar's most recent 10-K filing, the majority of solar module sales have been to countries with feed-in-tariffs or FiTs. Most countries with FiTs are in the eurozone. These developed countries have budgetary issues and are now entering an era of fiscal austerity. First solar explicitly lists this as a risk factor:
"The ongoing sovereign debt crisis in Europe and its impact on the balance sheets and lending practices of European banks in particular could negatively impact our access to, and cost of, capital, and therefore could have an adverse effect on our business, results of operations, financial condition and competitive position. It could also similarly affect our customers and therefore limit the sales of our modules and demand for our systems business as well. The European sovereign debt crisis may also cause European governments to reduce, eliminate or allow to expire government subsidies and economic incentives for solar energy, which could limit our growth or cause our net sales to decline and materially and adversely affect our business, financial condition, and results of operations." (First Solar 2011 10-K Filing for 2011)
Austerity measures would endanger significant geographic regions. Of the $2.8 billion in net sales recognized in 2011, $639.4 million were from Germany and $413.4 million were from France.
First Solar also blames the slowdown in European demand for its inventory buildup (10-K, p. 37). Inventories more than doubled from $195.9 million at the end of 2010 to $475.9 million at the end of 2011.
If the solar industry is simply a novelty without government subsidies, then First Solar should be compared to members of other heavily subsidized industries. Government subsidies are vulnerable to cuts from austerity measures taken by many governments.
Has the sun set on solar?
It should be noted that the future of the solar industry is not pitch black. At low volumes of production solar panels can be made from the byproducts of other semiconductors, which lowers the cost of production. Moreover, today's costs of production are low enough to make solar panel-generated power competitive with retail residential rates. If its products are economically viable, then FSLR can be reviewed based on its merits as an out of favor value investment.
To be fair, First Solar is able to produce solar modules at very low prices. After all, First Solar is the world's largest thin film solar panel maker. It is a low cost leader, with a $0.75 cost per watt in 2011 (10-K p. 38). If these modules age with degradation the 0.5% to 1.0% power output degradation experience by other, more expensive solar cells, then these cells could produce power at rates which are lower than retail residential rates.
Unfortunately, there might be a catch. Finding actual data to validate 10, or 15 year power output levels on new modules and technologies is impossible if you don't have a time machine. Worse yet, many solar panel purchasers do not measure output, but rather buy and assume that they are functioning at factory specifications. An article in AOL Energy has captured the frustrating lack of monitoring and optimism among solar owners. Most owners do not monitor the output of these investments.
Keeping this lack of field measurement in mind, low-cost Cadmium Telluride thin film solar panels such as those sold by First Solar are thought to have more rapid output deterioration over time than other solar cells. In particular, they are thought to have annual deterioration exceeding 5% per year. This could be problematic for First Solar if is warranties become costly to service.
First Solar provides warranties through its different business segments. Historically First Solar's components segment provided a five-year warranty, and has extended the warranty period to 10 years for units produced after September 30, 2011 (10-K, 6). This warranty covers defects. The firm also guarantees 90% of rated power output for 10 years and 80% of rated power output for 15 years.
If the degradation of these solar cells is an issue, there should be some hint of it in the liabilities of the company. The total warranty liability for First Solar's components business increased from $26.5 million at the end of 2010 to $155.5 million at the end of 2011. The current portion of the warranty liability increased from $9.8 million at the end of 2010 to $78.5 million at the end of 2011. These dramatic increases outstrip relatively tame sales growth since net annual sales have been between $2.0 and $2.8 billion for the past three years.
These issues make First Solar less attractive as a value play.
Better Government Spending and Energy Trades
If you are looking for an energy value play, consider Valero Energy (VLO), which recently traded near $29 per share. VLO shareholders have savored a 36.5% increase in share price over the past year, yet it is still cheap. At present, shares of this large-cap stock trade at a price-to-book ratio of 1.0, a price-to-earnings multiple of 7.8, and a price-to-sales multiple of 0.1 (trailing twelve months). At this price level, the stock has a 2.1% dividend yield.
Valero has a compelling history as well. For 10 out of the past 10 fiscal years, a share of VLO paid a total of $2.77 in dividends. Of these dividend payments, a total of $2.15 were paid in the last five years. Over the past decade shareholders savored a 12.5% average annual return on equity.
If you are looking for a play on government spending, consider Career Education (CECO), which recently traded near $8 per share. For-profit education relies heavily on government financing, and this company would certainly benefit from strong government aid programs. At this price level, shares of this small cap stock trade at a price-to-book ratio of 0.7, a price-to-earnings multiple of 4.0, and a price-to-sales multiple of 0.3 (trailing twelve months). Over the past decade, shareholders savored a 14.0% average annual return on equity.
Valero and Career Education are better ways to play energy and government spending.