First Solar Is Oversold, Even With Falling Polysilicon Prices

Apr. 9.12 | About: First Solar, (FSLR)

Fear abounds for investors in First Solar (FSLR), and with good reason too. The thin-film PV systems manufacturer has had numerous shake-ups in recent months and is facing one of the most challenging markets in its corporate history.

The American solar play gained widespread fame following its introduction to the public markets in November 2006. The company prospered as its stock soared beyond the $300 mark in 2008. Yet as this corporate Icarus touched the sun, First Solar began to plummet to depths that would've been unheard of in years prior. Today, as investors flee and even find easier money in shorting the company rather than taking long positions, one begins to wonder if the sell-off has truly become justified.

From a valuation standpoint, First Solar appears cheap:

  • Current Price (4/6/12): $20.98/sh
  • Market Capitalization: $1.81 Billion
  • Forward P/E Ratio: 4.89
  • Price/Book Ratio: 0.52
  • Book Value Per Share: $42.14
  • Current Ratio: 2.68
  • 52-Week Change: -85.76%

So what is it that really appears to be scaring investors away? Management issues, a business transitioning away from a subsidy-supported model, and a falling European market aside, the largest underlying fear lies in the possibility of China's solar companies eventually preventing a sustainable business model. The fear is that traditional PV system manufacturers (which rely heavily on polysilicon) could render First Solar's thin-film modules (which rely on cadmium telluride) useless by producing more volume and at cheaper prices than First Solar is able to do.

While undoubtedly this rests as a possibility, it's important to remember that the solar market is one that is growing, and there will likely be room for multiple leaders. The end goal is really grid parity. If you are able to produce at a level that allows for your power source to sell at cheaper levels than existing prices for the alternative, you will likely have a sustainable market to be a part of. Solar in many ways has already reached the level of grid parity. The cost of PV systems have already fallen well below that of nuclear power for instance, and solar power undoubtedly is here to stay with the rising cost of fossil fuels.

However, let us explore the thought of how well First Solar can hold up against it's competition. The following excerpt was taken from the most recently filed 10-K reflecting the year end for 2011:

"We are the lowest cost PV module manufacturer in the solar industry for modules produced on a commercial scale, based on publicly available information, and our average manufacturing cost per watt declined from $0.77 during 2010 to $0.75 during 2011 . This cost advantage is reflected in the price at which we sell our modules or fully integrated systems and enables our systems to compete favorably in respect of their [return on equity] or [levelized cost of electricity]. Our cost competitiveness is based in large part on our proprietary technology (which enables conversion efficiency improvements and enables us to produce a module in less than 2.5 hours using a continuous and highly automated industrial manufacturing process, as opposed to a batch process), our scale, and our operational excellence. In addition, our modules use approximately 1-2% of the amount of semiconductor material (i.e., silicon) that is used to manufacture traditional crystalline silicon solar modules."

Let us remember that First Solar is still the leader when it comes to commercial cost. Its advantage is derived from an automated process that significantly reduces the cost of time needed to produce their inventory. Coupled with the very low use of raw material compared to its competition, the company is able to produce product at a very low rate - an advantage that is unlikely to be disturbed. However, let us also consider the effect commodity prices can have on the competition's ability to compete. The filing adds the following thought:

"Although we are not a crystalline silicon module manufacturer, we estimate, based on industry research and public disclosures of our competitors, that a $10 per Kg increase or decrease in the price of polysilicon could increase or decrease, respectively, our competitors' manufacturing cost per watt by approximately $0.05 to $0.08 over time."

The question therefore remains, how much lower can costs really go for the polysilicon manufacturers? As it stands, they are just beginning to be able to compete with First Solar when it comes to cost. With spot prices in the mid $20s range, there's clearly a floor to be set in terms of how much additional advantage the competition will be able to gain out of falling polysilicon prices. Based on the previous statement, we can assume a maximum additional gain of $0.10-$0.16 cost per watt were the polysilicon market to truly become amazingly efficient to support $5/kg prices. Yet any rational investor should realize this is unlikely.

However, the drop has been significant, and it's this acceleration in the falling cost of the competitor's products that has alarmed investors in First Solar. From March 2011 to December 2011, polysilicon prices fell from $80/kg to less than $30/kg. Prices may even stay low for some time as the Chinese government continues with its unsustainable policies that have helped drive prices to these levels. This sudden price cut by the competition have many investors afraid of where it can go from here. But ultimately, those afraid of the polysilicon-reliant manufacturers have but to only ask themselves a single question: In light of all that is going on, can First Solar continue to compete in the market today? The answer is clearly "yes."

Have the company's profit margins been hurt? Yes. Have their forecasts been cut? Yes. But are they doomed to fail? Well, at least the market continues to think so based on the current valuation of First Solar's stock. Never mind that First Solar remains operationally profitable when all of their public competition around them have failed to do so in the current market. As a caveat, one should remember that the reason it had a loss in the past quarter was due to the wiping out of goodwill that was accounted for in its acquisitions of OptiSolar in 2009 and NextLight in 2010. These valuations were based on expected synergies, economies of scales, and vertical integration that was to be realized and have now been deemed worthless. Therefore, taking these one-time losses out of the picture, the company had actually continued to be highly profitable. Let us consider the public competition:

Name Market Cap. Tot. Cash Current Ratio Fwd. P/E Price/Book
First Solar $1.81 B $672 M 2.68 4.89 0.52
Yingli Green (YGE) $532 M $891 M 0.98 38.22 0.65
Trina Solar (TSL) $536 M $817 M 1.76 10.63 0.45
JA Solar (JASO) $245 M $618 M 2.32 N/A 0.23
SunPower Corp (STP) $484 M $492 M 0.81 N/A 0.53
Click to enlarge

We see that First Solar has been hit just as hard as it peers in light of deteriorating circumstances in the solar market. Nevertheless, the company remains well financed with a strong current ratio compared to some of its peers. Above all, the company is expected to be highly profitable going forward as its peers still struggle to accomplish this fundamental feat. In the most likely scenario, all of these companies will continue to do alright going forward, but for our purposes such comparisons should show that First Solar is far from a failed investment that it's currently priced at.

While the future remains entirely unclear for First Solar, it also remains highly unlikely for the company to go belly-up in the near future, or even over the next few years. Investors should remember that this is a company that has enjoyed almost six years of subsidized growth as a public company. Its balance sheet remains highly fortified, and its manufacturing capacity has grown in a sustainable fashion.

Above all, the company remains profitable in a market that is continuing to grow (albeit with severe market shocks) when its competition has failed to do so. Changes will be necessary, and efficiencies will have to be obtained. But is the company sounding a death knell? I, for one, think not. Investors looking to open a position in the company, but protect themselves from part of the downside potential, should consider my other article here.

Disclosure: I am long FSLR.