SUMMARY
- First Solar is the leading solar manufacturer for commercial installations with a cutting edge technology that allows it to enjoy pricing advantages over its peers.
- Being a product leader has proved to be a sustainable moat itself over the long-term.
- As the world’s energy consumption shifts towards cleaner options such as solar and wind, First Solar stands to benefit from untapped markets to fuel its expansion.
Introduction
During our primary school days, we were taught that the Sun is the primary source of energy in this world. It warms the planet, drives hydro-logic cycle and makes life on this green planet possible. While there are other natural forms of energy to be harnessed such as wind, the Sun contributes largely to other forms of energy through the role that it plays in the solar system. And since there is an overflowing abundance of it, why shouldn’t we harness it?
First Solar Inc. (NASDAQ: FSLR) has been doing that with increasing efficiency since 1999, growing into one of the industry’s most successful companies. With nearly $3 billion in revenue in 2016, it is one of the few solar panel manufacturers that consistently churns a positive net income. On top of that, it has maintained for itself one of the most stellar financial positions in the solar industry. However, the thing that caught my eye about this business is that First Solar is a product leader in its own field. Combine that with a sound business strategy and an industry which recently suffered a downturn and you get a business that might be a prime candidate for your portfolio.
Business Model
First Solar made its name with low-cost solar panels based not on the usual silicon, but on a thin film of cadmium telluride (CdTe) deposited onto glass.
CdTe solar cells are the second most common photovoltaic (PV) technology in the world marketplace after crystalline silicon, currently representing 5% of the world market. CdTe thin-film solar cells can be manufactured quickly and inexpensively, providing a lower-cost alternative to conventional silicon-based technologies. The film also brings about several advantages over silicon – It absorbs more frequencies of light and hence, functions better in low-light overcast conditions while having a higher tolerance level for heat. It requires less material to make and the absorption layer can be 100 times thinner than an equivalent silicon panel. Lastly, it is lighter than the typical silicon solar panel which is an advantage in large installations.
While the advantages of using CdTe solar cells are broad and appealing, it brings about two drawbacks which First Solar needs to address: It is normally less efficient than silicon and cadmium is toxic.
First Solar has work its strategy around these two weaknesses and thus, focsuses on commercial buildings rather than residential ones. After all, commercial clients are less concerned about CdTe panels and deemed them to be relatively safe to use.
Laying out and executing a strategy within the commercial space has proven to be extremely successful for First Solar. On a sunny day, its thin-film installation operates almost as efficiently as other sources of energy such as coal, nuclear and even natural gap on a cost-per-kilowatt-hour basis. The US government has also doled out a 30% tax credit that was suppose to expire at the end of 2016 but was extended through 2019 before it ends. Upon expiration in 2021, commercial customers will receive a 10% credit in perpetuity.
By focusing on commercial installations rather than residential, and by greatly lessening its reliance on government incentives, First Solar has managed to stay at the forefront of its industry.
Competition
Despite having found success in the commercial market, First Solar needs to be prepared for a tough fight as it expands into other regions and markets.
China’s National Energy Administration recently decided to lower its 2020 target for cumulative solar installations from 150 gigawatts to 110 gigawatts. This has exacerbated a price war between the three leading silicon-panel manufacturers, Trina Solar, JinkoSolar, and Canadian Solar.
From here, two major problems arose. Firstly, these companies depend on volumes to keep their cost per unit down. Secondly, inventory has piled up immensely for these companies. As a result, every company in this space has moved on to cut prices on their goods in order to liquidate their inventory quickly so as to ensure their working capitals are robust. First Solar did not participate in the price cut and hence, sales have fallen from $3.57 billion in 2015 to $2.95 billion in 2016.
In November 2016, management decided to accelerate production of a new module called the Series 6. With improved efficiency and a larger footprint, the Series 6 would lower the “balance of system” cost of installation which includes inverters, wiring, switches, mounting, and other items. With added improvements to its new line of products, new installations are expected to be cheaper and more efficient than silicon panels.
Due to intense competition from other manufacturers and a move to transit from one product line to another, First Solar’s finances took a huge hit. Operating expenses for the Q4 of 2016 included approximately $8 million for the impairment of development costs associated with the Tribal Solar project. For the full year, adjusted operating expenses were $388 million. Restructuring and asset impairment charges to accelerate its Series 6 transition was $729 million and $819 million for the fourth quarter and full-year 2016 respectively. As a result, the company reported a net operating loss of $503 million. The path forward will likely continue to be rocky and investors ought to adjust their expectations for that.
Risks
The nature of the industry that First Solar operates in is a risk factor by itself. The industry has been plagued by players burning though a ton of cash before heading into bankruptcy. Being in a capital intensive requires a company to have sufficient cash cushion to withstand any unforeseen shocks it may receive. First Solar’s capital expenditure in 2016 was slightly larger than its operating cash flow and required the company to dip into its cash reserves to tide over the period. Given that it has plenty of cash on its balance sheet, First Solar seem to be able to cope with its expenses for now.
Managing inventory will also be a challenge for companies in the solar industry. After all, the company has accelerated the production of the Series 6 and it will be looking to sell off Series 4 inventory at a discount. Hopefully, it will be able to liquidate its inventory fast enough rather than delay a sale as the company needs to recognise that its first loss will be its best loss. Liquidating its inventory quickly will allow it to free up cash and reinvest it in a more meaningful way. At least half of its Series 4 inventory has been sold and guidance for revenue has been boosted. Analysts are seeing if the company can gain a toehold in pricing leverage with its customers and ride out the industry down cycle.
Conclusion
Solar panels are ultimately a commodity product. While Tesla’s Solarcity has been developing panels that are not only cost efficient but also aethetically pleasing, customers from both the commerical and residential might still choose one that has the best performance at the lowest cost. First Solar has a huge upside going forward and being a product leader in its field allows it to maintain a sustainable economic moat. With $2 billion of cash and a modest amount of debt on its balance sheet, investors should see plenty of upside to come.
Marcus Ho
Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.
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