First Solar Inc.'s (NYSE: FSLR) Analyst Day guidance exceeded consensus expectations, particularly in the area of conversion efficiency; the company increased the target efficiency of its modules from 17.2% to 19.5% by 2017. According to the efficiency/cost roadmap provided by FSLR, the conversion efficiency of thin-film Cadmium-Telluride (CdTe) is expected to surpass that of PV Silicon by 2016. Should the target level of efficiency be achieved, FSLR will have the opportunity to penetrate the rapidly-developing distributive generation (NYSE:DG) market in North America. Unlike utility-scale projects, DG requires a higher level of efficiency because of the limited space available on rooftops. Japan is the perfect example of a market that FSLR can penetrate with its new technology, due to the limited geographical space available for solar panel installations within the country.
The journey to cost reduction. FSLR is expected to lower its module costs to $0.35 and its Balance of System (BoS) costs to below $1/watt; this will significantly increase the company's success in the US DG market. The above numbers imply a 11% yearly average cost cut for modules and a 12% yearly average cost cut for BoS within the next few years. After raising the target efficiency of thin-film CdTe modules, FSLR's cost reduction targets are more achievable, as the increase in conversion efficiency alone will lead to a 9% yearly average cost cut. Deutsche Bank (NYSE:DB) analysts state that more than 10 U.S. states have currently reached grid parity, and nearly all of the 52 states are predicted to reach grid parity by 2016. According to DB, Solar LCOE in grid parity states ranges from 11-15 c/kWh, compared to retail electricity price of 11-37 c/kWh. Due to the improved economics of solar in these markets, along with factors such as solar leasing and low cost financing, an installed capacity growth of ~600% is expected over the next 3-4 years. Solar system prices are expected to decline from sub $3/W to $2.50/W over the next 12-18 months. With broader acceptance of yieldco-type structures, solar financing costs are expected to decrease by ~200-300 bps (with solar LCOE decreasing from 10-16 c/kWh to 8-14 c/kWh), and capital flow to the solar sector is expected to increase significantly.
Cadmium-Telluride (CdTe) technology. Going forward, management will emphasize thin-film's potential due to the R&D breakthroughs and successes that FSLR has experienced in 2013. Thin-film can be used to replace PV silicon in the DG business if it can achieve an efficiency level higher than that of PV silicon. Although Cadmium alone is a toxic substance, Cadmium-Telluride is not; hence, the product is not expected to be banned by any governments.
Valuation. There are mixed views on how FSLR should be valued. The most common approaches include: P/B, P/E, and DCF. Some analysts do not like using P/B because it does not account for the differing returns on equity across various solar verticals; others do not like P/E because it captures a large part of FSLR's legacy business (which is less likely to be dominant going forward). If FSLR is able to breakthrough into the DG segment, FSLR appears to be relatively cheap on a price to book basis (trading at 1.5x) compared to its competitors Solarcity (NASDAQ: SCTY) and Sunedison (NYSE: SUNE), which trade at 17x and 18x respectively. First Solar has also guided roughly $25/share of cash on its balance sheet by year-end 2015, hence giving the company ample cash in a rapidly evolving industry. Analysts expect FSLR to earn $2.59/$4.7 in 2014/2015 respectively, therefore if you discount $25/share of cash by 20%, FSLR is trading at an undemanding ex-cash 2015 P/E multiple of 11.7x.
Effect of the US International Trade Commission (ITC). An important catalyst to consider is the federal investment tax credits (ITC) expiration in 2016. The federal ITC reduces the tax liability for individuals or businesses that purchase qualifying solar energy technologies. By the end of 2016, if a 30% ITC is maintained, ~47 states are expected to reach grid parity; however, only ~36 states are expected to reach grid parity if the ITC is reduced to 10%. For this reason, a big rush of new installations ahead of 2016 ITC expiration is expected. Ultimately, the availability of a residential leasing option would also act as a significant growth catalyst for the sector considering the fact that solar leasing companies are highly profitable and have strong incentive to maximize number of leasing customers ahead of the ITC expiration in 2016. The future for solar in North America and across the world seems to be bright as system prices are reduced.
FSLR is expected maintain a competitive advantage, in terms of their technology, as new competitors have been focusing on cost reduction rather than improving the efficiency of their modules.
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Disclosure: I am long FSLR.