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First Solar - Series 6:  Fiercely Competitive Technology

|About: First Solar, Inc. (FSLR)
Summary

Announced initiatives will reduce S6 CpW by roughly 40% by 2024 (from $0.255 /w in 2019 to $0.144 / w in 2024).

Modest CapEx investments will expand throughput of the existing S6 factories from 6600 MW to 8580 MW by 2024.

Implementation of First Solar’s CuRE (copper reduction) program will increase S6 Module output from 430 watts per panel to 500 watts per panel by 2024.

Average Selling Price (ASP) will decline by roughly 12% over the next 5 years (from $0.345/w in 2019 to $0.30/w in 2024).

Earnings per share will increase from $3.50 per share in 2020 to approximately $9.00 per share in 2024 driven by expanded profit margins, improved module efficiency and increased Series 6 production volume.

This is the second of a 2-part investigation of First Solar.  This study focuses on the Modules Segment which houses the company’s thin film CdTe panel manufacturing capability.  Part 1 covers the Systems Segment which has historically provided EPC and O&M services, along with world-wide utility scale solar energy project development.

Summary:

Having met its initially announced (2016) objective of reducing the production costs of the Series 6 product by 40% compared to that of the Series 4 panel, First Solar has now announced a 5-year plan to further significantly reduce Series 6 cost per watt (CpW) along with substantially increasing the throughput of its recently retooled factories as well.  In light of these announcements, this study presents findings on production costs, margins, module output and earnings impacts as these plans are implemented over the next 5 years.

Company Background:

First Solar operated as an LLC from 1999 to 2006 and successfully commercialized its proprietary thin film CdTe solar cell technology.  After incorporating in February 2006 and conducting its IPO later that year, First Solar generated positive earnings ($3.97M on Net Sales of $135 Million) in its first year.

In August of 2013, First Solar acquired General Electric’s patents and other intellectual property related to thin film CdTe solar technology in exchange for 1.75 million shares of FSLR common stock (valued at $82 million).  GE agreed to retain the stock for at least 3 years and to provide R&D collaboration.  This action doubled First Solar’s thin film patents, advanced their manufacturing technology and led to GE’s exit from solar energy development with cancellation of their plans to expand solar manufacturing operations in Aurora, Colorado. 

The Modules Segment suffered dramatic reductions in Net Sales (over 50% decline) in 2012 as Germany and other European countries unwound their feed-in tariffs that up to that time had supported the sole market for First Solar’s products.  First Solar was forced to abandon its expansion strategies and write-off over $1B in the form of impairments and restructuring costs (2011 – 2013) as it closed its factory in Germany and cancelled construction of new plants in Arizona, France, and Vietnam.  In 2016, First Solar abandoned its TetraSun division and most of its Series 4 manufacturing in order to convert these factories to Series 6 production.  This decision led to an $820 Million write-off against earnings in 2016.  The earlier action taken in 2012 to ramp up the Systems Segment provided a timely increase in sales and earnings just as the Modules Segment ran into these headwinds in addition to the more recent unexpected earnings impacts in the form of a $372 tax expense in 2017 arising from President Trump’s Tax Act, and the $363 litigation expense incurred in 2019 from settlement of a 2012 shareholder lawsuit. 

Launch of Series 6

Fierce competition has compressed margins and served to inspire innovation and cost reductions.  But even though the global footprint of solar energy has expanded as the levelized cost has moved to the front seat on an unsubsidized LCOE basis, demand has generally failed to keep pace with supply since 2011.  As a result, premier solar manufacturers such as First Solar have cultivated a culture of continuous improvement to keep their offerings competitive.  This process, fueled by a generous R&D budget has led to an endless stream of incremental product upgrades to improve efficiency and throughput.

However, in 2016 First Solar committed to a step change approach through the introduction of its Series 6 solar module.  This design ramps up the power output by about 250% (from 130 watts to 440 watts per panel) and integrates with over 40 different manufacturer’s structures and tracker systems.  The panel’s physical dimensions increased from essentially a 2 ft x 4 ft panel to a 4 ft x 6.5 ft panel.  This size was selected to optimize the field installation effort (maximum size suited for a 2-man lift) and incorporates many construction-friendly features that appeal to customers as they seek to achieve the lowest possible installed system cost.  This design effort appears to have hit the mark and the Series 6 product commands a premium of about $0.03 per watt over the Series 4 ASP due to its contribution to lower balance of system costs.

Importantly, the Cost per Watt (CpW) is 40% lower than the Series 4 panel, further improving margins.  Not surprisingly, First Solar has committed virtually all of its manufacturing capacity to the production of the Series 6 module, and is completing a $2.5 Billion investment this year to expand production to achieve 6.6 GW of capacity to manufacture the Series 6 product.  The company’s current plan is to idle its last remaining Series 4 factory (Factory 3 in Malaysia) in the 2 nd quarter of 2020 (resulting in a combined severance / impairment cost of about $30 Million).  No decision has been made yet concerning conversion of this facility to manufacture the Series 6 product.

The sweeping changes to their manufacturing processes involving robotics and high-tech tooling carries an imbedded execution risk.  Recent company disclosures from First Solar are somewhat opaque regarding the specifics of their proprietary thin-film technology.  However, their first published annual filing (2006 10-K) does provide a little insight into what’s involved:

“We have integrated our manufacturing processes into a single production line with the following three stages:  The “deposition” stage; the “cell definition” stage; and the “assembly and test” stage. Except for operators performing quality control and monitoring functions, the only stage requiring manual processing is the final assembly and test stage.

As a result of our automated production process, we employ 20 people per production line for each of our four shifts, or a total of 80 people per production line for 24 hours per day, seven days per week production.

The deposition process begins with the robotic loading of 2ft × 4ft [now 4ft x 6.5 ft] panels of low-cost tin oxide-coated soda lime glass on to the production line where they are cleaned and chamfered to produce the strong, defect free edges necessary for subsequent processing steps. Following cleaning, the glass panels move automatically into a vacuum chamber where they are heated to near the softening point and coated with a layer of cadmium sulfide followed by a layer of cadmium telluride using our proprietary vapor transport deposition technology. Each layer takes less than 45 seconds to deposit and uses approximately 1% of the semiconductor material used in crystalline silicon solar modules. Our ability to deposit the semiconductor materials quickly and uniformly is critical to producing low cost, high quality solar modules. Next, we cool the semiconductor-coated plate rapidly to increase its strength. The deposition stage concludes with a re-crystallization step that reduces defects within the crystals and minimizes the recombination that occurs between grain boundaries.

In our cell definition stage, we use a series of lasers to transform the large single semiconductor-coated plate into a series of interconnected cells that deliver the desired current and voltage output. Our proprietary laser scribing technology is capable of accomplishing accurate and complex scribes at high speeds.

Finally, in the assembly and test stage, we apply busbars, EVA (Ethyl Vinyl Acetate) laminate, a rear glass cover sheet and termination wires, seal the joint box and subject each solar module to a solar simulator and current leakage tests. The final assembly stage is the only stage in our production line that requires manual processing.”

It is likely that the current production technology differs in many ways from First Solar’s initial manufacturing process described above, but this overview provides some insight into the complexity of the process.  It seems no small challenge to produce 15 million solar panels per year, and First Solar has addressed a large imbedded risk by reaching their production goals (with plans to far surpass them) very much in line with their initial commitments.

Stock Price Performance:

However, these accomplishments have not been rewarded by the market.  Indeed, the disappointing earnings reported in Q4 2019 due in large measure to the $363 Million litigation expense arising from the settlement of a shareholder lawsuit (along with general market concerns about the coronavirus outbreak) prompted a dramatic selloff that brought the share price down from $60/sh to an intraday low of $42.50 on February 28th, well below book value of $48.50/sh. 

First Solar [NASDAQ:  FSLR]  28 Feb 2020;  Open:  $42.55; Low:  $42.50; High:  $46.65; Close:  $45.77

First Solar has guided to 2020 earnings of between $3.25 and $3.75 per share, with 80% of this performance expected in the last half of the year as the first 2 quarters will be weighed down with ramp and start-up costs ($55 to $75 Million) along with impairment and severance expenses ($30 Million) related to shutting down its last Series 4 factory in Malaysia.  This disclosure implies an expectation of exiting 2020 with quarterly earnings of approximately $1.50, with production continuing to ramp up and costs rapidly declining in 2021.  Should First Solar achieve these targets in 2020 and guide to earnings in excess of $7.00 in 2021 as this study indicates, share price could double over the next 12 months.

Operating Results:

PV solar technology is now the least cost generation alternative (even without the benefit of the ITC) and numerous market indicators point to a favorable outlook for solar energy (see Part 1).  However, solar panel manufacturers have consistently ramped up production capacity, and oversupply continues to put downward pressure on module pricing.  In light of this, an assumption of declining Average Selling Price (by 12% over the next 5 years) is assumed in this analysis.

Although not highlighted in its presentations or earnings call, First Solar disclosed in its 2019 10-k filing that it began an extended service life depreciation approach (from 10 years to 15 years) applied to its Series 6 manufacturing equipment.  First Solar disclosed that it employs straight line depreciation methods, which when applied to an estimated $3.4 Billion total book value of the module segment assets suggests that this change would result in an annual reduction in cost of goods sold of over $100 Million.  Of interest is the probable underlying expectation that the cost structure of the Series 6 product is becoming so attractive that economic obsolescence and early retirement must appear to be highly improbable concerns (both to First Solar and its auditor).

First Solar is reluctant to provide production cost estimates related to its Series 6 product, other than to say that they expected cost reductions on the order of 40% over the Series 4 product when they launched the retooling investment in 2016.  First Solar believes that disclosure of CpW data might put downward pressure on average selling prices, with customers tending to negotiate to a ‘cost plus’ price point rather than offering the full value this technology provides.  In order to investigate the relative impact each of First Solar’s cost reduction initiatives have on Cost per Watt, estimates of the cost inputs have been made to demonstrate the sensitivity to the announced near to mid-term developments.  Here are the results:

The most significant expected impact to the company’s financial performance arises from the announced expansion of Series 6 production as First Solar implements targeted throughput optimization projects.  This effort improves margins by spreading fixed costs over higher production volumes as well as generating additional product to market.  The results of this improved factory utilization is presented below:

The simultaneous implementation of multiple significant process and technology improvements offers the potential to reduce overall module production costs by about 40% while expanding production capacity by over 30%.  It then would come as no surprise that modeled future financial performance is quite impressive should First Solar be able to achieve the improvements they have identified.

Financial Model:

Technology Improvements

First Solar’s thin film CdTe technology provides superior ‘in the field’ performance due to its better response to the elevated humidity and temperature environment solar panels typically operate in relative to prescribed test conditions.  In addition, the company has announced plans to increase the output of each panel (from 430 watts to 500 watts) as it implements its CuRE (copper reduction) program.  First Solar anticipates that this action will further improve its humidity and thermal response as well as lead to improved power loss characteristics as well.

First Solar currently offers a performance guarantee that solar panel output will not decay by more than 0.5% per year following commissioning, either on a panel by panel basis or as measured relative to an entire project’s performance.  Data presented in Berkeley Lab’s latest report on utility-scale solar energy highlights a surprising trend consistent across the fleet of installed solar energy projects:  On average, solar energy output is typically declining by 1.2% per year (see figure below).

           https://emp.lbl.gov/sites/default/files/lbnl_utility-scale_solar_2019_edition_slides_final.pdf

 As First Solar further improves its energy decay performance, backed by warranted contract language, this should lead to further interest in their S6 modules.  Successful marketing of the Series 6 total value attributes would be indicated when Lazard and other investigators no longer see a reason to distinguish economic and operational metrics based on thin film vs. crystalline silicon PV technology.

Final Remarks

Despite the market’s recent reaction to First Solar’s earnings and guidance, the company’s management team and employees appear to have made commendable efforts over the past three years to implement a far-sighted strategy that should position the company in an enviable position in the solar PV space.  With each S6 factory’s commissioning and ramp-up to full production, typically under budget and on schedule, risk has been reduced and better line of sight to the earnings potential behind this strategy has come into view.  First Solar has proceeded with prudence in its commitment to capital outlays, leaving sufficient resources available to handle unexpected setbacks such as the changes to tax policy and unexpected outcomes of pending litigation without compromising its strong, debt-free (excepting non-recourse project related financing) balance sheet.  Given that First Solar’s assets consist largely of cash, marketable PV projects and brand new factories that are uniquely designed to produce a product that few, if any can compete with, it seems surprising that its shares are trading significantly below its book value of $48.50/sh.

Disclosure: I am/we are long FSLR.