Is This Solar Stock About to Crumble?
Adrian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Investors acquainted with First Solar's (NASDAQ: FSLR) stock must be accustomed to extreme price movements. While the overall stock performance for the past 12 months is amazing (up by 95%), strong negative movements are also very common. And just after releasing earnings for the second quarter of 2013, the stock's price started to fall quite fast (-21% this month). Such movements are generally uncommon and show us that investors have little idea of how to properly value a solar energy company. Is First Solar stock about to crumble?
Understanding First Solar
First Solar designs and manufactures solar modules using a proprietary thin film semiconductor technology, one of the best in this field. In theory, this technology can help to reduce the cost of solar electricity to levels that could be comparable to the retail price of electricity. The key issue here is that this technology is currently under development, and First Solar has been reducing the cost per watt every year.
If First Solar succeeds, it will become the main player in a new, more expanded and stronger solar industry. As a result, investors not only need to pay attention to the company's fundamentals; they also need to pay attention to operations metrics like production, capacity utilization and cost per watt.
Now that we know what to watch, let's start with how First Solar is doing with its technology. The latest earnings call showed production increased 5% quarter-over-quarter, while cost per watt decreased by $0.02, to $0.67.
Source: First Solar Investor Relations, Presentation slides
It looks like the company is doing a good job of reducing the cost of solar energy. But is First Solar's cost per watt among the lowest in the industry?
According to Morningstar, the lowest-cost Chinese companies, including Trina Solar Limited (NYSE: TSL) and Yingli Green Energy Holding Co. (NYSE: YGE), achieved total module costs of $0.64 (including warranty, freight and stock comp expenses) in early 2013. If First Solar wants to succeed, it will have to outpace its Chinese competitors by a wide margin. And that doesn't look so feasible in the medium run.
Trina Solar in particular, the fourth largest solar module company in the world according to the Renewables 2012 Global Status Report, won't be easy to beat. The company may have billions of off-balance sheet liabilities and low gross margins because of increasing competition (in the third quarter of 2012, it only made 0.8%.) However, I believe that Trina's story is far from over.
Although revenues have suffered the consequences of fierce competition, Trina is one of the very few that can develop monocrystalline ingots, wafers and even cells. This allows the company to enjoy a vertically-integrated supply chain. With more than 380 solar photovoltaic patents filed, net revenue decreased in the last quarter but the company still emphasizes cutting-edge research that could bring cost per watt even lower.
According to the latest earnings call, revenues for the second quarter came in at $519.8 million, down 46% compared to last year and quite below the Street consensus estimate of $721 million. Revenues fell by 31% compared to the first quarter, and the company's guidance was also updated.
First Solar will hold two system projects and spend more money at its AV solar plant. As a result, full-year revenues are now expected to be somewhere in between $3.6 and $3.8 billion, down $200 million from the previous guidance. The upside is that gross margins are expected to improve slightly. The guidance is 22%-23%. Operating income, on the other hand, is down $25 million from the previous guidance.
First Solar has a wonderful story behind its stock, but the business is full of risks. It could be a wonderful investment if it actually manages to reduce the cost per watt to a level as low as electricity. That's going to take years of cutting-edge research, and investors need to be patient before seeing consistent profitability.
However, it's a fact that as First Solar gets closer to its long-run objectives, competition will increase. Even if First Solar manages to take the cost of solar energy to a level as low as electricity, it may never enjoy high margins. That won't be a problem as long as the company manages to position itself as one of the main leaders in this new industry. That implies surpassing the lowest-cost Chinese companies by a great margin.
In this sense, Yingli Green Energy may be a better alternative to First Solar. The company just signed an agreement with the world's largest solar wafer producer, GCL Poly. Under this three-year agreement, Yingli will be able to meet future expansion needs and get cheaper prices for bulk orders of polysilicon and solar wafers. This is a strong advantage considering that the average spot price of polysilicon increased 11% this year. Yingli expects panel sales to be 3.2 gigawatts to 3.3 gigawatts this year, up about 40% from a year earlier. Yingli may also have more stability than First Solar because it has been able to maintain its market share in China for the past quarters; that market share is a stable part of its revenue base.
The road to success in the solar industry is full of challenges, and First Solar won't be alone in the competition. I doubt the company will quit the game anytime soon, regardless of volatility, but if it really wants to conquer this market it must do something more than just catch up with the Chinese competitors.
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