In my previous article, The Tellurium Supernova, I discussed the rapidly expanding new applications of the extremely rare metal tellurium, and that looming global shortage of telluriumcould threaten the very survival of the red hot solar company, First Solar Inc. (NASDAQ:FSLR), which produces solar PV panels based on the CdTe (cadmium telluride) semiconductor material.
The Tellurium Supernova article caused quite some disturbance on the internet. Not every one agrees with me. But I am happy that Mr. Free Market does seem to agree with me. The charts show that tellurium price staged an incredible rally since mid January, raising from 860 yuan to 2100 yuan per kilogram, or $300 per kilogram, a raise of 2.44 fold in less than three months. Tellurium went from $10 a kilogram in 2004 to now over $300. If such a stellar price rally does not indicate a severe global shortage of tellurium, then I don't know what does.
The Tellurium Supernova has erupted!
Does First Solar feel the squeeze of a tellurium shortage? Maybe not. At a conference last November, the CFOclaimed (22:58) "We have identified terawattslevels of tellurium availability." So the ultimate limit to the growth is one terawatts? No! The CEO proudly declared"Are there issues there that limit the ultimate size of the company? We think the answer to that is NO." Wow! I never knew that FSLR can grow without ultimate limit of size, even though they rely on a metal with extremely limited supply.
FSLR, as well as its dominant raw material supplier, 5N Plus Inc. (OTC:FPLSF), repeatedly reassured people that it is not worried about tellurium availability and they are actively "managing it." But I noticed that it would NEVER divulge anything specific or anything quantitative when it comes to its tellurium supply. In multiple occasions, analysts, including Michael Molnar from Goldman Sachs, explicitly demanded specific and quantitative answers, but got only the vague go-around answers. Why is the company not willing to reveal any data on tellurium?
Fortunately, 5N Plus, the virtually exclusive high purity CdTe and dS supplier to FSLR, is now a publicly traded company and must file regular financial reports, allowing us to dig out some useful information. You can go to Sedar.com and search for "5N Plus" to find all 5N Plus regulatory filings. I think the 5N's Dec. 12, 2007 prospectus document is worth reading through carefully. It discusses a lot of details of the industrial use of high purity tellurium, and its relationship with FSLR. You might also listen to latest conference call. A few important things to note from the prospectus:
- 5N Plus is the first to enter the market of high purity tellurium metal and compounds. It has years of expertise, large scale production capacity, and business relationship with tellurium sources. It is the world's dominant CdTe supplier and all dTe solar PV manufacturers purchase CdTe from them.
- 5N Plus is a virtual monopoly in this niche market. The barrier of entry is too high for a second major CdTe supplier, and the market is too narrow to provide enough economic incentive for competitors to enter this small niche market and compete with 5N Plus. FSLR desperately wanted to diversify its CdTe sources but there is just no significant secondary supplier in existance in the world. It refuses to name the secondary supplier. Does it even exist at all? 5N already named all of its few potential competitors.
- It is safe to say SLR gets virtually all of its dTe supply from 5N Plus. 5N Plus has plenty of production capacity, 100 metric tons of CdTe annually, and under contracts with FSLR, it is building a new Germany facility, bringing the annual capacity to 200 metric tons and eventually reaching 350 metric tons a year. Why would 5N expand if FSLR does not continue to heavily depend on 5N for supply?
- 5N noted rapidly expanding industry demand on tellurium. It mentioned 300 metric tons of start metals per year for thermoelectrics applications (page 21). That number really strikes me. According to USGS, global tellurium supply can not be much more than 200 metric tons per year. Thermoelectrics usage of tellurium wasn't even mentioned a few years ago. Now that market alone consumes 143.4 metric tons of tellurium (48% of the Bi2Te3 thermoelectrics material is tellurium).
So we can pretty accurately estimate FSLR's raw material supply by looking at how much CdTe 5N is selling to FSLR. 5N refused to provide numbers in kilograms, but it gave a price range of C$300 to C$500 per kilogram during the Q2 conference call, and suggested in Q3 conference call that the price may exceed the top of the range now. So using $500 per kilogram, one can get some reasonable numbers. 5N also revealed that 60% of sales was to FSLR, and 65% to 70%.
Let me list 5N's quarterly sales revenue, as well as cost of goolds sold (in bracket) below. Note their fiscal year 2008 starts on June 1st, 2007. Q3,08 is the quarter ending Feb. 29, 08.
Q3,08 C$8.359M ($3.905M) OP. Margin C$4.454M
Q2,08 C$6.796M ($3.519M) OP. Margin C$3.277M
Q1,08 C$6.394M ($3.417M) OP. Margin C$2.977M
Q4,07 C$6.549M ($3.442M) OP. Margin C$3.107M
Q3,07 C$5.555M ($3.419M) OP. Margin C$2.136M
Q2,07 C$4.890M ($2.779M) OP. Margin C$2.111M
Q1,07 C$4.903M ($3.122M) OP. Margin C$1.781M
I noticed one curious thing. During the past quarters, even though the sales revenue saw some growth, the growth is not impressive at all. The cost of goods sold saw virtually no growth at all, while the operating profit jumps up rapidly!
Put it in a chart you can see the data more clearly. In the chart, blackis FSLR's rapidly ramped up quarterly production in MWs, red is 5N's cost of goods sold, blue is sales revenue, and green is gross operating profit.
Notice the gigantic contrast between how quickly FSLR's production ramped up, and how there is virtually no increase in 5N's cost of goods sold? Logically, as FSLR ramps up production, it needs to purchase way much more CdTe semiconductor material from 5N. Hence, 5N needs to spend more money to purchase the raw tellurium feedstock, not to mention the unit price of the feedstock raw material must increase dramatically as tellurium price went up a lot.
Something is not right here!
The rapid growth of 5N's gross operating profit, without much increase in the production cost, further enhances the logical wisdom that 5N enjoys an absolute monopoly in this small niche market of high purity CdTe supply, and hence can demand higher unit price as they see fit, while FSLR has nowhere to go but purchase the bulk of their CdTe supply from 5N.
My suspicion is FSLR is not getting all the CdTe it needs for its production. At 3 microns CdTe layer thickness, there's about 15 gramsof CdTe per 2 feet x 4 feet panel of 70 watts. Allowing for some production waste, 0.25 grams/watt CdTeis reasonable. FSLR produced 77 MW in Q4,07, that's a consumption of roughly 19.25 metric tons of CdTe. At over $500 per kilogram, that's worth C$9.625M of purchase from 5N. Add dS, which also came from NP, total purchase should be almost $11M for the quarter.
5N's latest quarterly revenue is only C$8.359M, and with 65% going to FSLR, that's C$5.433M. Split it into C$4.8M for CdTe and the rest for CdS, at over $500/kilogram, they sold about 9.6 metric tons of CdTe to FSLR. That's only about HALF of what FSLR would need!
From the 5N's cost point of view, about half of cost is salary, machinery and other fixed costs. Let's say C$2M of the C$3.905M cost in the quarter is on raw material purchase. SLR's portion takes 65%, or C$1.3M, tellurium price during the quarter probably averaged C$250/kilogram. So that gives 5.2 metric tons of tellurium, enough to make 9.8 metric tons of CdTe for FSLR, consistent with the above estimate, and inconsistent with FSLR's 19.25 metric tons requirement for quarterly production.
My conclusion, based on the best information available to me and the most logical and reasonable estimate, is that FSLR has already run into a raw material supply shortage due to the global shortage of tellurium. It is either now producing from the raw material inventory, or it probably booked quarterly sales but really could not produce and deliver the quantity of products it sold. Later this year and next, when its new Malaysia factories start production, I really have o idea how it is going to get the tellurium supply it needs.
I contacted SLR investor relations and raised the CdTe supply issues more than a month ago and asked for a clarification, and never got any response. I am hoping that FSLR can come out and clarify how and where it is getting its critical material supply, how much it has secured, and how much they need. Of course, if there really is a shortage, the investor community has every right to demand that the FSLR management disclose the information fully and publicly, as soon as it knows it, as required by the SEC regulations.
Disclosure: The author is heavily invested in the stocks of PAL and SWC but holds a small short position in FSLR since April 4th. I plan to add to my short position when the time is right.