America’s largest solar company, First Solar (NASDAQ:FSLR), has largely under performed in the broader solar sector this year. While firm’s like SunPower (NASDAQ:SPWR) and Trina Solar (NYSE:TSL) have seen their stock prices rise by around 300% and 140% respectively since January on the back of rising demand and shipments, First Solar’s stock is up by just over 20%.
While factors such as a Q2 earnings miss and a downward revision of annual guidance are partly responsible for the firm’s under performance, we believe that there are some key risks that could be weighing on the stock, including the firm’s middling progress in bagging new systems projects bookings this year as well as concerns about the competitiveness of the company’s thin-film panels.
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Cd-Te Thin-Film Panels Are Falling Behind Silicon Based Panels
First Solar’s panels are manufactured using thin-film cadmium-telluride (Cd-Te) technology. Historically, thin-film panels have typically been cheaper than polycrystalline based panels, although they have offered a lower conversion efficiency. However, over the past two years, Cd-Te thin-film panels have seen their price advantage practically vanish as competition among Chinese polycrystalline panel manufacturers as well as lower polysilicon (an input used to manufacture polycrystalline panels) costs have driven down the prices of polycrystalline panels sharply. Now, while polycrystalline based panels still remain more efficient compared to First Solar’s thin-film panels (14% to 15% efficiency for polycrystalline vs. about 13% for First Solar), they are also significantly cheaper. Most Chinese polycrystalline panels currently sell for between $0.60 and $0.65 per watt while First Solar’s manufacturing costs alone amount to around $0.67 per watt meaning that its panels should cost at least 10% more compared to polycrystalline panels. (Related: Are First Solar’s Thin-Film Panels Falling Behind?)
Over 70% of a solar power system’s costs come from balance of systems equipment (BOS) such as structural components, electrical equipment, labor and other soft costs. Since BOS costs are also a function of the size of the panels, this means that First Solar’s less efficient panels would require more structural and mounting equipment for each unit of installed capacity, which could actually drive up overall systems costs. While the company’s panel sales to its power plant projects continues to be strong, the firm’s technological disadvantage has reflected on the results of standalone panel business as panel sales to third parties fell from around $1.5 billion in 2011 to around $325 million in 2012.  Although the company has been taking some steps to bolster its panel technology off late by acquiring GE’s thin-film intellectual property, besides venturing into the silicon based panel space through its acquisition of TetraSun. It remains to be seen whether these investments will payoff since the firm has yet to begin production from these technologies.
Systems Business: Slower Bookings, Risk That Margins Could Be Impacted
First Solar’s systems business has been the driving force behind its performance over the last several quarters. While the company’s outlook for the systems business is quite positive and expects it to drive overall revenues to as high as $4.8 billion in 2015, most of this guidance comes from uncommitted projects.  Additionally, the company has been executing its systems contracts at a faster pace than it has been adding new bookings. As of August 2013, the company’s total backlog of bookings fell to 2.2 gigawatts (GW) from around 2.6 GW in the beginning of the year. While this is quite concerning, the company says that it is has been pursuing new booking opportunities to the tune of around 1.3 GW.
In Q2 2013, First Solar’s systems business had gross margins of close to 45%.  These high margins are due to two reasons: firstly, the systems business involves providing value added services such as engineering, procurement and construction, and secondly, the prices for these projects are typically negotiated in advance to construction. Most of the projects for which the company has been recognizing revenues for off late are likely to have been negotiated a few years ago when the solar sector was healthier and pricing power was still relatively strong. However, we believe that profitability for this segment could be impacted going forward by the weaker pricing environment as the company may not be able to sign projects at the same rates that it had been doing previously.Notes: