First Solar Is Worth About $27 On Strong Project Pipeline

In an industry roiled by heavy losses and bankruptcies, First Solar (NASDAQ:FSLR), a vertically integrated manufacturer of solar equipment, continues to stand out. The company distinguishes itself from the rest of the solar pack thanks to its strong financial position and focus on the photovoltaic (PV) solar systems business, which offers higher margins and faces lower competition.

Forward Integration Enhances Value Capture

Apart from selling modules to systems integrators and project developers, First Solar has been rapidly forward integrating its business through its PV solar systems segment to build large-scale solar farms. This shift is attractive on numerous fronts. Given the large quantities of panels required for solar farms, economies of scale in manufacturing will improve. Also, since rates are negotiated by long-term contracts, it reduces the company’s vulnerability to panel price fluctuations and allows for better production management. Although the entry barriers to the business are not particularly high, winning contracts requires technical expertise and a strong track record, which the company has been building on over the last few years.

Last year, the photovoltaic systems business accounted for just 25% of the company’s sales; however, this year has seen a complete reversal in the company’s revenue mix with the systems business contributing a whopping 67% of sales. The profitability of the systems business has also seen an improvement with gross margins rising by about 5 percentage points to 36% while gross margins for the modules business dived due to a decline in selling prices.

In view of the firm’s strong growth outlook in the profitable systems segment, we have increased our price estimate for the company from $22.13 to $26.84. The systems business now accounts for 61% of the Trefis price, while the module business accounts for the remaining 39%.

Strong Financial Performance and Position

The company expects sales for 2012 between $3.5 billion and $3.8 billion, which represents growth of at least 27% over last year. The firm’s gross margins are also quite healthy at 24% compared to other manufacturers who are struggling to recover production costs. First Solar also has the most robust balance sheet in the industry with total debt of just $530 million and cash of over $700 million. This gives the company a positive net cash position unlike most firms in the industry that are suffering with deep debt.

The strong balance sheet is an added advantage in the projects business since customers like utility firms seek vendors who are capable of executing projects smoothly without concerns of bankruptcies and other financial issues. The healthy cash position also means that the firm stands in good stead to acquire new technology and make acquisitions, taking advantage of weak valuations in the solar industry.

Low Polysilcion Prices And Increase In Systems Competition Pose Risks

First Solar manufactures its modules using Cd-Te thin film technology. Although Cd-Te based modules are less efficient than those made from polysilicon, they have garnered market share thanks to their low cost (almost 30% cheaper than polysilicon modules in 2011). Over the last year however, the excess supply of polysilicon has led to a decline in prices of polysilicon-based PV panels. This has eroded much of First Solar’s price advantage.  If polysilicon prices continue to remain depressed, it could have a negative impact on First Solar’s PV modules sales going forward as customers would opt for higher efficiency polysilicon modules. First Solar has been taking steps to improve conversion efficiency and lower costs by tweaking its manufacturing process to incorporate technologies like laser scribing and improved semiconductor deposition.

Although the firm is currently the leader in solar power systems space, other manufacturers like US-based SunPower (NASDAQ:SPWR)  have been making steady progress into the business. Chinese manufacturers like Suntech Power (NYSE: STP) are also testing the waters by building projects in China. Increased competition could decrease the pricing power and lead to margin compression in the future.

Understand how a company’s products impact its stock price on Trefis