First Solar (FSLR) manufactures solar modules using a proprietary thin film semiconductor technology. This process uses cadmium telluride to convert sunlight into electricity. First Solar uses about 1% of the material required to complete traditional crystalline silicon solar modules. First Solar's manufacturing process eliminates most of the supply chain that is required to produce silicon panels. During 2011, First solar produced 2 gigawats of solar modules, this number includes 510 megawatts during the fourth quarter. First Solar expects to expand capacity to 2.52 gigawatts during 2012. The company's production facilities are located in Kulim, Malaysia, Frankfurt, Germany and Perrysburg, Ohio. 67% of production takes place in Malaysia, 22% in Germany and the remaining 11% at the facility in Ohio. First Solar trades around $21 and has a market capitalization of $2.258 billion.
First Solar's manufacturing cost were $0.73 per watt in 2011's fourth quarter. This represents a 3% reduction from the previous year. First Solar's cost advantage allows the company to compete in non-subsidized markets in the North America, Europe and Asia. I would like to point out though that competitive pricing pressure form heavily subsidized manufactures in China are intensifying and taking toll on First Solar's profitability. The subsidies from the Chinese government allow these companies to sell their products below cost and remain in business, creating an unlevel playing field. First Solar believes it can improve efficiency and further reduce manufacturing costs to maintain its cost saving advantage over companies that use crystalline silicon. This will strengthen the company's position and allow First Solar to reduce the cost of capital that is required to invest in a solar power system; further enhancing the economic viability of future solar projects.
First Solar's sales were $2.77 billion in 2011. The company's growth rate since 2007 is 53%. In 2007, First Solar recorded sales of $504 million. Sales growth points out that the world is demanding alternative energy sources, if costs are on par with traditional sources of electricity. First Solar has great long term potential, however, in the current economy and unfair trade practices in China, the company's near term prospects remain uncertain.
On March 21st, 2012, the United States Government announced that duties ranging form 2.9% to 4.73% will be placed on Chinese solar products. These duties can be raised if The Department of Commerce finds further evidence of Chinese government subsidizing Chinese solar manufacturers. No anti-dumping duties have been assessed, and this policy will not be finalized until May, 2012. Chinese companies can get around these duties but setting up manufacturing facilities outside of China.
First Solar had a tough 4th quarter. The company took a $500 million in charge off which resulted in a loss for the year. Even in an unstable environment, First Solar's 2012 guidance for cash flow and earnings stayed intact. Even though First Solar is the best of breed for the industry, unstable fundamentals are going to make 2012 a difficult year, and I don't think solar is a safe sector for investors. Other than First Solar, the entire industry expects to lose money in 2012. S&P estimates call for First Solar to earn $3.93 a share in 2012, no estimates are available for 2013. At its current price, First Solar has an earnings yield of 19% based on 2012 estimates.
During the fourth quarter, sales grew 8.29%, totaling $660 million, versus $610 million in 2010. However, during this same period, accounts receivable grew by 174%, and inventory increased by 164.24%. These are signs that Fist Solar is having difficulty moving products and extending more credit; this creates the possibility of never getting paid. As percentage of current assets, inventory increased from 12.65% to 20.27%, and accounts receivable increased from 19.38% to 32.3%. Given the current operating environment, both of these numbers could be disastrous for First Solar.
When Germany and Italy cut subsidies to solar manufactures, this resulted in an oversupply that destroyed both pricing and margins. Supply and demand issues will continue though 2012. First Solar watched selling prices fall from a $1.54 in 2010 to the current level of $0.70. Price cuts have outpaced First Solar's ability to cut costs, squeezing margins even further. Fortunately for First Solar, the company has a large number of projects in North America which will offset margin pressures and will be a profit center for the company. First Solar's gross margin fell to 38% in 2011, down from 46% in 2010. First Solar expects gross margins to be around 28% for 2012. Analysts expect operating margins to drop from 16% in 2011 to 6.5% in 2016.
In the past, First Solar has outperformed other manufactures, based on the cost savings provided by First Solar's proprietary technology. If First Solar loses this advantage, the company's margins will fall in line with the rest of the industry. I am uncertain how much the company can grow over the near term; global and U.S. public policies surrounding solar energy are unclear past 2012. First Solar is also at the mercy of Chinese competitors, who, because of government subsidies, can price their products below fair market value. This impacts First Solar negatively, and the company is feeling the results of these irrational prices.
I like that First Solar is the only company in the industry with a meaningful intellectual property. First Solar also custom builds its production lines; this combination gives the company an advantageous cost structure that other companies are unlikely to duplicate during the next 3 to 4 years. First Solar holds the largest pipeline of new projects in North America. Morning Star estimates that 60% of First Solar's 2012 revenues will come from projects in North America, as demand shifts from highly subsidized European markets. First Solar's cost structure gives the company an advantage in markets that aren't as generous with subsidies.
The solar industry faces some pitfalls. The time of selling in high margin subsidized European markets is dead, and profitability is going to be lower for the whole industry. The current downturn is bad, and no end is in sight; with a plethora of oversupply, 2012 may be the worst year the industry sees. The only way customers are going to buy solar power without a subsidy is if they can get electricity at a substantial discount to more reliable sources. When you think about it, no electricity is generated when the sun is not shining; "grid parity" is still years away.
An argument can be built that First Solar is trading at a discount to its publicly traded peers; this is not quit true. Yes, it is true that First Solar is trading with a forward PE of 5.3, and that appears to be discounted compared to the industry. First Solar looks cheap compared to Sun Power (SPWR) with a forward PE of 11.2, Amtech Systems with a forward PE of 13.3, and Trina Solar Limited (TSL) with a forward PE of 12.2. Sun Power, Amtech and Trina trade around $6, $8, and $7, respectively. Just because the company looks like the prettiest troll under the bridge doesn't mean it's a bargain. Given the supply and demand issues and the loss of government subsidies, the current environment is just too uncertain for me to buy any solar stocks on an individual basis.
I want to end by saying that solar energy is not a fad. I believe in the long term viability of alternative energies, and as part of that model, solar energy makes sense. I can't advise buying individual stocks in the solar sector; the share prices of these companies have been pounded over the last couple of years, and the current uncertainty could lead to further erosion of share prices. One thing I do know is this, over time, three things are going to happen: Oil supplies will dwindle, oil prices will go even higher, and technology will improve, making the cost of solar panels more affordable. I think the best way to play First Solar is to buy the Market Vectors Solar Energy Index ETF (KWT). This is the safest way I can think of to invest in alternative energy sources. Market Vectors Solar Energy Index trades around $3 and First Solar makes up 6.28% of the ETF's holdings.
Disclosure: I am long (KWT)