First Solar: A Low Beta Solar Play In An Extremely Volatile Sector

Summary

• With 90% of its business this year and 70% of its shipments next year already booked, First Solar's earnings should be fairly set in stone with little room for deviation.
• Due to fixed contracted pricing, First Solar could miss a big opportunity for margin expansion as peers are forced to raise pricing in order to compensate for higher input costs.
• First Solar's conservatism will also likely limit upside potential should the industry rebound from its recent supply side constraints.

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The solar industry has garnered a lot of attention in recent years as the effects of climate change have become more noticeable. The hype and criticism over photovoltaics have also made the sector incredibly volatile. As a result, U.S. listed solar stocks have always been a favo1rite among momentum traders. For both traders and investors, understanding the solar industry's cycles can reap huge rewards since boom and bust cycles can often turn on a dime with rallies potentially exceeding 1000% from trough lows. First Solar (NASDAQ:FSLR) is the exception. As the chart below shows, FSLR's gains since the start of 2020 pale in comparison to most of its U.S. listed solar peers. While the company's conservative management style has produced more stable earnings relative to some peers, the same conservatism may hinder upside potential when the industry rebounds from its recent cycle trough.

(Chart shows relative performance of key U.S. listed solar stocks since the start of 2020. Companies include First Solar, SunPower (SPWR), Enphase Energy (ENPH), SolarEdge Technologies (SEDG), Daqo New Energy (DQ), Canadian Solar (CSIQ), and Jinko Solar (JKS). Chart source: Seeking Alpha.)

First Quarter 2021 Earnings Recap

Although it may seem First Solar posted a big earnings beat, Q1 2021 results were not directly comparable to analysts' estimates. Management had already stated first quarter earnings would benefit from asset sales which could account for around $1.00 in after-tax EPS. Excluding capital gains on the company's U.S. solar project development and operation/management businesses, adjusted EPS of roughly $1.00 would have missed Wall Street's average consensus of $1.18.

As I detailed in a past First Solar article, investors should not be too concerned with the company's quarterly results. The lack of operational transparency makes it difficult to accurately estimate the company's manufacturing gross profit and the lumpiness of its solar project sales make it impossible to estimate its systems revenue in any given quarter. The wide discrepancy between posted results and analysts' average estimate also suggests some analysts excluded asset sale gains while others included them. For the most part, these quarterly variations often cancel out over the course of a fiscal year. For this reason, investors should refrain from excessive bullishness or bearishness over any single quarterly result. In many cases, any significant post earnings reaction could be faded for a short term trade.

The Positives

Despite major supply chain constraints which have crippled manufacturing gross margin for many of its peers, First Solar was able to post 20% adjusted module segment gross margin in the first quarter. In comparison, silicon based peers Jinko Solar, Canadian Solar, and Maxeon Solar reported adjusted module manufacturing gross margin of 17%, 10%, and 9% respectively. Rising input costs particularly polysilicon has increased manufacturing costs for nearly all of First Solar's peers and for the first time in nearly a decade will likely help First Solar regain its previously held title of lowest cost producer.

First quarter module segment gross margin could also mark the lowest level for 2021. Although management did not provide a gross margin update, previous guidance made during its fourth quarter 2020 earnings conference call predicted manufacturing gross margin would expand from 19% in Q1 2021 to 26% in Q4 2021. First quarter GAAP manufacturing gross margin was exactly as guided at 19% and were impacted slightly by ramping and utilization penalties of 1% in total. While the gross margin upside will likely be impacted due to more recent indications described below, First Solar's module segment gross margin should gradually improve for the rest of this fiscal year.

Overall, First Solar kept its previous fiscal 2021 GAAP EPS guidance of $4.05 to $4.75 unchanged. While annual revenue guidance at the top end range was increased marginally by $25 million, gross profit's low end range was decreased by $15 million due to input cost pressures, noticeably freight cost. Since 90% of the company's business has already been booked, investors should expect very little change in its annual guidance throughout the remainder of the year.

The Negatives

While First Solar kept its fiscal 2021 GAAP EPS guidance unchanged, this is hardly a positive. First, the range for this year's GAAP EPS guidance is extremely wide at $4.05-$4.75 so it would be extremely hard for the company to miss. Secondly, after excluding about $1.00 in EPS from one time asset sales, the lower end of this guidance would represent an 18% annual decline from 2020's $3.73 in GAAP EPS while the top end would translate to flat GAAP EPS growth. Thus, despite a potential 45% increase in megawatts shipped, adjusted earnings growth in 2021 could be flat at best.

Part of the reason for a potentially stagnant earnings year is the company's transition away from U.S. solar project development, sales, and maintenance businesses. For 2021, management expects annual systems segment revenue to range between $400 million and $450 million. This compares to $975 million booked in 2020. With $268 million already booked in the first quarter alone, decelerating systems segment contribution for the rest of this year will partially negate any potential benefit from increased module shipment volume in the seasonally strong second half.

Although very subtle, the module segment update management gave during its first quarter earnings conference call was not favorable. As I noted in my previous First Solar article, First Solar is more hedged than most of its peers. However, it now appears the cost side was not fully hedged at least for the duration of an entire fiscal year. Due to increased freight cost and the rise of certain raw materials such as aluminum, manufacturing cost reduction this year is now expected to range between 6% and 7%, down from last quarter's guidance of 8%. With module average selling prices [ASP] expected to be down 10%, any downside revision on the cost side which is off a lower base will further magnify margin contraction.

Moving forward to 2022, First Solar also revised module ASP decline expectation to 11% and off an increased percentage of shipments. In the previous quarter, management expected module ASPs to decline by 10% for the 5.9 GW of booked shipments. This has now been revised to an ASP decline of 11% for 6.4 GW of booked shipments next year. Not only are ASPs slightly weaker than previously expected, but First Solar now has potentially less than 30% of its annual shipments next year available for ASP increases. Had the company not been conservative and booked less of its future sales at fixed pricing, it could have increased ASPs to match the industry since many silicon based peers have or will have to increase ASPs by 20% to 30% to correspond to higher input costs.

Management downplayed the opportunity to increase pricing and stated they did not want to gouge their customers. However, if peers have to increase pricing due to cost pressures, it would be downright foolish in my opinion for the company not to increase ASPs to match the market for new orders. If First Solar does not raise new order ASPs for the decreased available shipment allotment next year back to pre-pandemic prices, current analysts' average EPS estimate which calls for a 15% annual decline will look more and more likely. Since First Solar does not have a history of under promising and over delivering, its earnings momentum in the short to intermediate term will likely be stagnant at best. In the past 12 quarters, the company has missed Wall Street EPS estimates 8 times.

Final Thoughts

Since First Solar does not give exact shipment data, it is impossible to accurately estimate its quarterly module ASPs and manufacturing costs. Quarterly ASPs can also vary greatly due to geographic mix for any given quarter since pricing in the U.S. is generally higher than most parts of the world due to Section 201 and Section 301 tariffs. However, directionally I estimate First Solar's Q1 2021 module ASPs decreased by 2% sequentially while manufacturing costs increased by 7%. This resulted in the sequential decline of adjusted manufacturing gross margin from 27% in Q4 2020 to 20% in Q1 2021. In contrast I estimate both Jinko Solar and Canadian Solar booked a sequential ASP increase of roughly 8% in the first quarter. Maxeon Solar (MAXN) which did disclose exact shipment and revenue metrics saw a sequential blended ASP increase above 15%.

All silicon based peers stated that ASPs will have to continue to increase to match input costs, although this process may take several quarters. Had First Solar used the same business practice as nearly all of its peers and operated at current market pricing, it would have experienced tremendous margin expansion. Differential input costs and a new product cycle are estimated to reduce manufacturing costs by 6-7% this year. In contrast many silicon based peers are currently experiencing an incremental increase in manufacturing costs by as much as 40-50% above last year's pandemic lows. Now the best case scenario for First Solar would be to price unallocated production volume at higher current market pricing just to help mitigate contracted ASP declines for 90% and 70% of 2021 and 2022 shipment volumes, respectively.

The obvious question is why did First Solar price future orders so low? The answer at least in part is because the company books a lot of its expected production volume two to three years ahead. With a good portion of its costs hedged, the company has a good idea of its future manufacturing costs. Many orders booked before December 2020 also likely priced in ITC tax credit reductions of 4% annually. As part of the pandemic stimulus package passed late last year, solar ITC tax credits were extended for an additional two years without any further reduction. This now allows ASPs to remain stable from pre-pandemic levels and the reduction of long term interest rates can now support even higher ASPs.

While the current operating environment is horrible for First Solar's silicon based peers, they have more upside potential as pricing normalizes within their supply chain. Thus many peers should start to experience upward earnings momentum in the following quarters while much of First Solar's business is fixed for this year and most of next year. For momentum traders seeking positive earnings delta, First Solar will thus look extremely unattractive and as a result its low beta trading pattern may persist in the short to intermediate term.

For investors who want to avoid volatility, First Solar is still a good option as a solar investment. Even if annual EPS declines by 15% next year, FSLR would still be trading under market multiples at 24x earnings. If the company can raise pricing for its unbooked volume, the expected increase in shipments next year should at worse case keep annual EPS stable at above $4.00. While not cheap using historical metrics, 21x earnings would be considered discounted in today's high liquidity market. Since the solar sector has been historically extremely volatile with sentiment changing on a dime, any positive mood swing could still result in meaningful multiple expansion for FSLR from current levels.

An example of positive news flow is any news relating to the increased tension between the U.S. and China. While purely symbolic because virtually no solar panels manufactured in China are exported to the U.S. due to tariffs already in place, recent news regarding the banning of solar products linked to Chinese companies specifically involving Xinjiang did give FSLR a short term boost. First Solar's recent U.S. manufacturing expansion announcement citing potential incentives and lower capital costs also gave its stock a short term boost. Since I believe tensions between the two countries will only escalate, news flow on this front should continue to be positive for the company. While I would not chase rallies in its stock, FSLR could still yield above market returns for investors buying on the dips.

Disclosure: I/we have a beneficial long position in the shares of CSIQ, SPWR, MAXN, DQ, ENPH either through stock ownership, options, or other derivatives. 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.