A CNN headline reads: "$8 million in assets - and can't get a mortgage." If banks don't lend money to prospective homeowners with uncertain earnings potential -- even if they're sitting on valuable assets -- should you invest in a company with uncertain earnings potential simply because it's sitting on a cash pile? Enter First Solar (NASDAQ:FSLR). As of Q4 2016, FSLR is sitting on cash of $1,955M with very little debt ($188M). Therefore, at a current market cap of $2,770M, FSLR has a price/cash ratio of 1.43. To put this in perspective, a price of $18.75 would put FSLR on sale for -- in the language of some bulls -- "free."
Why, then, has FSLR dropped from $60 to $26.54 in one year, precariously approaching its "free" price? The same reason you can't get a mortgage simply because you have a giant bank account: Cash means nothing vs. the possibility of weak future cash flows. And weak future cash flows is the fear du jour for FSLR, which has seen its cost-leading technology lose out to a massive economies-of-scale strategy by Chinese producers such as Trina Solar (NYSE:TSL), JinkoSolar (NYSE:JKS), and Canadian Solar (NASDAQ:CSIQ).
Should we have more confidence in FSLR's future earnings potential than the market? My answer is yes. Although I've been bearish on FSLR recently, I'm doing an about-face after some thorough research. Here, I will show that the solar photovoltaic (PV) market is strong, that FSLR can compete in this market with its new Series 6 (S6) module, and that FSLR is a good value at current prices.
Long-Term Demand for Electric Utilities Is Strong
Global energy demand is forecast to rise 48% from 2012 to 2040, at a compound annual growth rate (CAGR) of 1.4%. Furthermore, this 1.4% CAGR is the minimum value for new utility installations because as old, carbon-based projects run out their lifecycles, new utilities will pick up the demand. For example, the ITRPV sees solar PV installations increasing in a base case at CAGR of 9.6% through 2050. Figure 1 illustrates historical global utility trends, which highlights solar PV's remarkable run so far.
Source: Created by author with data taken from EIA Electricity.
Intricacies of Regional Mix Complicates Demand Predictions
However, solar PV will not continue its current growth unless costs decrease. Eventually, solar PV must compete on the global electricity production stage without tariffs. In order to compare the financials of solar PV vs. other utility categories, the go-to metric is the levelized cost of electricity (LCOE).
McKinsey showed that in 2012 solar PV was only cost-competitive in niche regional markets -- e.g., remote areas with a lot of sunlight (Figure 2C). Promisingly, panel costs have dropped by 50% since the report. But regional sunlight, costs, and competing electricity sources still dictate solar PV demand, especially in the absence of tariffs. For example, I provide a realized cost curve of new utility installations in China and the U.S. in Figures 2A and 2B.
The upshot is that the market for utility solar PV module producers is large and growing. That said, the cost curve in North America (Figure 2B) is skewed toward the higher cost producers such as solar and wind. Thus, as solar PV matures into an industry competing without tariffs, LCOE must breach 0.09 $/kWh in high-growth regions such as India and China.
Series 6 Cost Per Watt Can Get to 0.09$/kWh
What can FSLR do to get to 0.09 $/kWh? They have two primary levers: module cost of goods sold (GOGS) and module power, which together set the average selling price (NYSE:ASP) of a module to a utility installer.
Note: 1000W/m 2 is considered standard solar insolation in full sunlight. I calculated FSLR's ASP in Q4 2016 as $0.47/W.
But even $0.47/W no longer makes the cut. Since solar PV is at the high end of the cost curve (Figure 2), the current oversupply is wreaking havoc on margins. Apparently, only one strategy is an option: reduce gross margins, a race to the bottom. Indeed, the solar industry has negatively deviated away from its ASP learning curve by about 20%, suggesting that companies are sacrificing margin to continue shipping product. This cannot be sustained indefinitely.
FSLR's strategy to lower cost per watt is to make a much larger module than the norm, while still being compatible with standard Balance of Systems (BoS) components. This increase in area allows FSLR modules to generate more electricity than smaller silicon modules, even at lower efficiencies. All the while, unlike its indebted competitors, FSLR is able to use its own funds to implement innovation.
Figure 3 highlights that we can trust FSLR's management that S6 will deliver costs less than $0.40/W. Importantly, I find that this will allow installers to breach $0.09/kWh.
Source: Created by author.
I show in Figure 3A that FSLR expects an increase in watts per area for S6 of 5.4%. Since they do not claim a cell efficiency increase, the 5.4% increase must come from better utilization of area via the form factor. Figure 3B shows that the wasted area on the S5 can reasonably account for the 3.4% needed to make up an efficiency walk from S5 to S6, after accounting for an electrical design benefit of 2%. In Figure 3C, I travel along a constant cost-per-area curve from S4 to the S6 efficiency, which allows me to estimate a range of possible costs for S6.
Finally, I perform LCOE simulations with my own Matlab model to estimate S6's competitive advantage for utility installers. (Note: I borrowed values from NREL and Mercom Capital in my model and corroborated my values with NREL's System Advisor Model.) Figure 4D illustrates that in regions with sun hours greater than six, FSLR's S6 modules should be competitive at a 25% gross margin. Importantly, FSLR's Indian projects such as Telangana and Karnataka are examples of regions where S6 will be competitive.
I haven't entered the "micro" debate of FSLR's CdTe thin film technology vs. the silicon behemoths. This is on purpose. At a macro level, I believe that any solar company that gets to the 0.09$/kWh promised land should succeed; they will no longer be a marginal producer and there's plenty of demand to go around.
Still, solar PV is ultimately a commodity market. FSLR attempts to be differentiated through vertical integration, with about half of their revenues coming from owning or operating solar PV plants. This allows for BoS cost innovation. Also, FSLR's technology has a climate-based advantage: CdTe performs better at high temperatures and in diffuse light. Using published data, I confirm FSLR's claim that in hot, humid regions these benefits can make up more than 5% efficiency vs. silicon technologies.
Source: FSLR Technology Update.
NREL estimates that tellurium accounts for $0.03/W of FSLR's module cost, which is a low material cost vs. silicon modules. But current global tellurium production will not be able to support CdTe growth to 10GW per year. While NREL sees a pathway to keep tellurium costs in check, it is worth an investor's time to convince themselves that tellurium costs will not balloon if CdTe grows in capacity. It is unclear whether FSLR is vertically integrated into tellurium mining.
Silicon Learning Curve
The silicon learning curve is steeper than that of CdTe (Figure 5). This puts FSLR at risk of losing a long-term economies of scale battle with silicon manufacturers. However, with module costs now less than 50% of installation costs, most of the solar PV industry cost gains will come from BoS cost reductions. I'm also less convinced than others that CdTe is on a different learning curve than silicon. Furthermore, as shown in Figure 5, even if the learning curves are correct, CdTe is competitive at 10% of the scale of silicon through 106 MW (1 TW) of capacity.
Source: Trina Solar Presentation.
CIGS, junction-cells, perovskite, and unknown techs always have a chance to upend the market. Remember, this is a race-to-the bottom commodity business.
And last but not least, it's unclear if S6 plus incremental efficiency gains, BoS cost reductions, and module cost reductions will be sufficient to compete well into the future (five to 10 years). We've learned from the S4 to S6 transition that a significant form factor change is a major factory overhaul. If there needs to be an S7 in another few years, and then an S8, and so on, FSLR would not be able to keep up. This is because the capital needed for form factor upgrades with thin film is much greater than that with silicon.
Monte Carlo Simulations Suggest a CAGR of 10%
Finally, I tested the sensitivity of FSLR's stock price in late 2019 against the scenarios outlined above. I probed variables as follows:
- EV/EBITDA between 6 and 10
- Debt between $290 and $500 M
- Cash between $800 and $2000 M
- Module revenue at $0.45W * 3.5GW = $1,575M
- Systems revenue at 50% to 90% of module revenue
- EBITDA margin between 8% and 16%
From my simulations (Figure 6), the mean CAGR is 10%.
Source: Created by author.
First Solar's stock price has been beaten down by the market for understandable reasons; there are many uncertainties related to their future earnings. This fear has led to cheap valuations approaching the cash level of the business. I've demonstrated that S6 will be competitive at launch not only against other module producers, but more importantly against other utilities.
Thus, I recommend building a position starting from the current price, and averaging your cost basis down if the opportunity presents itself.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.