First Solar: Don't Sell

| About: First Solar, (FSLR)
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Saudi Arabia has recently announced plans that should provide the entire solar power industry including First Solar (NASDAQ:FSLR) with an overdue and much-needed shot in the arm. The country is looking to identify investors to participate in a plan to build 41 GW of solar power generating capacity at a cost of $109 billion and built a sustainable solar power industry.

You may think it strange that one of the largest oil producers in the world is paying so much attention to solar energy but there are good reasons why this decision makes sense. In the first place, Saudi Arabia gets plenty of sunlight and experts say that it would only need to use a small fraction of its land mass so that solar energy becomes an attractive alternative is the costs of generation drop. In the second place, it is expensive to generate power from oil because oil is sold to energy producers at a fraction of the open market price. The process will commence sometime in 2013.

First Solar and SunPower (NASDAQ:SPWR) seem like good candidates to benefit from this initiative but there are problems involved. Saudi Arabia is likely to stipulate local manufacturing and is just as likely to meet with a lukewarm response from suppliers as India has recently done. The large Chinese manufacturers such as Yingli Green Energy (NYSE:YGE), Suntech Power (NYSE:STP), and JA Solar (NASDAQ:JASO) rely heavily on the Chinese government for funding and I doubt whether the Chinese government will view major manufacturing investments outside China favorably.

Though the solar power industry concentrates primarily on solar panels, Saudi Arabia will also consider the use of concentrated solar power for up to a quarter of its requirement. Companies involved in concentrated solar power include BrightSource Energy and eSolar, both funded by Google (NASDAQ:GOOG). As the costs of solar energy continue to drop, more countries are finding it an attractive investment and cost-effective instead of generating power from oil.

First Solar is a leading manufacturer of thin film solar panels and was once a highly regarded stock. However, the stock price has since taken a beating along with the rest of the industry generally. This has been caused by the strength of bad news over the last year about its projects as well as the oversupply of solar panels in the entire industry.

Several analysts have downgraded the stock from "buy" to "neutral" recently. One major area of concern has been the company's large exposure to Europe where the economic problems are forcing governments to cut back on solar power subsidies. Germany and Spain, hitherto two of the largest proponents of solar power, are both cutting back. The solar trade dispute between the US and China over the dumping of crystalline silicon solar panels on the market at prices below the cost of production has subsequently driven down prices for FSLR thin-film solar panels as well. These problems have resulted in frequent reshuffles in the top management.

Another problem area for the company has been financing and loans are often guaranteed if conditions relating to government permits are fulfilled. Last week, it had to make an SEC filing disclosing that Antelope Valley Solar Ranch contract, based in northern Los Angeles County, which it sold to Exelon Corporation l last year would have to be repurchased if the project is unable to secure a loan of $646 million from the US Department of Energy which is in turn subject to construction permits. The company also plans to cut back production by 20% to tackle the oversupply problems. It has eliminated its manufacturing plans in Vietnam and deferred the construction of its Mesa, Arizona full-scale manufacturing plan indefinitely. In addition, production will be reduced in the German plant and government assistance has been sought to avoid mass employee layoffs.

First Solar competitors have not been doing particularly well either. Suntech Power has lost money in the first quarter of this year because of reduced shipments as well as lower prices. Like all other manufacturers, it has been affected by the economic conditions in Europe with the sales of solar panels are the highest in demand has declined drastically because of subsidy cutbacks. SunPower has different kinds of problems in the form of criticism from environmentalists for its new 110MW US project. Environmental concerns include interference with kit foxes that live in the vicinity as well as the effect on the viability of future farming on the land. JA Solar has some good news to offer because it believes that its shipments of solar panels to the United States will not be affected by pending US tariffs.

First Solar is likely to have another problem in exploiting the potential in Saudi Arabia, Israel and the Middle East because the thin film that they use on their panels can develop defects when used in areas of high temperature. They need to gear up their technology to develop more rugged film that can be more appropriate for these areas. Moreover, the Saudi Arabian bonanza will only materialize in 2013. Moreover, some experts also believe that there could be major legal problems ahead for the company.

Despite the undoubted potential of the solar energy business, I still have my doubts about the immediate prospects. Conditions still need to stabilize and costs will possibly have to drop further to encourage mass scale adoption. Only when the costs of generating solar power are comparable to the costs of generating power from oil without the help of subsidies will the industry become truly viable. For now, I am neutral on First Solar stock and would not recommend a buy at this point of time until there is more clarity about the future. If you have an existing holding in the stock, things could hardly get any worse. I recommend that you hold in the prospect of an upturn in the price in a reasonable period of time.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.