This Solar Stock Is Set to Soar

Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Thanks to the rising environmental concerns and depleting hydrocarbon resources, the demand for solar power is increasing around the globe. Despite the towering installation costs of large-scale Photovoltaic (PV) modules, a recent report claimed that the global PV module industry could fatten up to $138 billion by 2020. That is an impressive annual growth rate of 51%, which gives investors an opportunity to capture this tremendous growth potential. I believe that First Solar (NASDAQ: FSLR) is one of the best investment options available.

One less competitor

Although First Solar’s full year guidance was lackluster, its deal with General Electric was a big achievement. As per the terms of the agreement, First Solar will acquire GE’s Cadmium Telluride (thin film) technology and GE will be paid 1.75 million shares of First Solar; these shares will come with a lock in period of three years. Once the technology rights have been transferred, GE will cease manufacturing thin film PV modules.

It's worth noting that the thin film technology has set First Solar apart from its peers. Since GE has been giving the company stiff competition, the acquisition of its rival’s technology (and market share) will certainly bolster First Solar’s growth. It will also strengthen its market position in the coming years.

The management of First Solar believes that the economies of scale will also help in cutting down R&D expenditures and manufacturing costs. This is why many analysts are urging investors to buy the stock on weakness, despite the pessimism regarding the timing of the acquisition and its expected payback period.

Margin Expansion

Keeping aside the 31% year-over-year sales decline in the second quarter of 2012, investors should note that First Solar’s gross margins improved by 460 basis points sequentially. And on a year-over-year basis, its gross margins have grown by 1,156 basis points (around 76% improvement.) Its management stated that manufacturing costs per watt slid by 3% sequentially during the quarter, which coupled with a 13% improvement in conversion efficiency led to margin expansion.

Excluding the inorganic margin growth potential from its latest acquisition, analysts expect its margins to improve organically. A recent report by GTM Research suggested that the production costs of PV modules can fall by 28% by 2017, due primarily to technological advancements. This, coupled with First Solar’s low utilization rate of 75%, also presents a bullish outlook. With the rising demand for PV modules, its utilization will gradually increase and will eventually lead to better economies of scale. As a result, I believe that First Solar stands to benefit from micro and macroeconomic triggers.

Sound Fundamentals

Not all solar companies present robust growth prospects, however. JinkoSolar (NYSE: JKS) and LDK Solar (NYSE: LDK) are China-based manufacturers of PV modules, but both of them are loss-making companies. Their towering debt levels pose a threat to their mere existence.

As of now, LDK Solar operates with a ridiculously high debt-to-equity ratio of 105 times. Its total debt aggregates to $5.7 billion, out of which around $2.8 billion is short term and $2.917 billion is long term debt. Talking about the 2014 fiscal year, the company has around $260 million of debt maturities to repay. Since it generated just $39.9 million in operating cash flows during the 2012 fiscal year, I don’t see how even debt restructuring can break it out of its debt entrapment.

On the other hand, JinkoSolar operates with a relatively better, but high debt-to-equity ratio of 4.21 times. It operates with a current ratio of just 0.8 times, which indicates that its liquid positions are spread pretty thin. Toss in its current liabilities of over $1 billion and operating cash flows in the 2012 fiscal year of just $112 million, and its balance sheet looks pale. Since its gross margins have compressed by 62% over the last three years, its growth prospects seem to be limited.

Unlike its smaller peers, First Solar operates with a healthy current ratio of 2 times and an impressive debt/equity ratio of 15% (most of which is long-term debt). Its shares have more than tripled over the last year, and Argus recently upgraded its shares with a price target of $55 per share. In my opinion, its sound financial position makes it a relatively safe value play.

Final words

It's worth noting that First Solar manufactures PV modules and also takes orders for industrial-scale solar project installations. This has created a worldwide dependence on the company for solar projects, adding more growth prospects in its kitty. After acquiring its competition, First Solar seems well poised to grow at a rapid pace.

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Piyush Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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