First Solar (NASDAQ:FSLR) reported a strong set of Q3 earnings last week aided by robust revenue recognition on its solar projects. While the results broadly reflected the improving conditions in the solar industry, the company also made some important manufacturing and business development-related improvements such as expanding its project order book, cutting production costs and improving the conversion efficiency on its panels. We believe that these developments bode well for the company’s future earnings growth and considering the better outlook, we have increased our price estimate for First Solar from around $44 to about $58, which is slightly below the current market price. Below is a brief summary of the rationale behind the changes to our price estimate, the modifications to our valuation model as well as the impacts of the changes.
Expanding Order Book: We had been somewhat concerned about First Solar’s systems order book over the last few quarters, since its systems sales had been exceeding new bookings. However, the company made some solid progress in building its order book during the third quarter, adding close to 860 MWdc of new orders, bringing the company’s total outstanding bookings to around 2.7 gigawatts (GW). Additionally, the company indicated that it has new booking opportunities to the tune of about 7.7 GW, out of which around 1.4 GW of projects are mid to late stage deals with a reasonably high probability of materializing. We believe that the expanding order book should allow First Solar to grow its systems revenues going forward. We have increased our forecast for First Solar’s systems sales to about $3.65 billion by the end of the Trefis forecast period (FY 2020) and we have also marginally increased our forecast for the systems gross margins to about 38%. These changes increased the price estimate by roughly $3 per share.
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Balance Sheet Remains Among Best In Solar Industry: First Solar maintains one of the most stable balance sheets in the solar industry. During the third quarter, the company’s cash and cash equivalents rose by over $250 million to close to $1.20 billion while the total debt fell to around $230 million.  Having a strong financial position is an asset for solar project developers such as First Solar, since customers signing long term contracts typically look at the financial stability of the vendor. We have increased the company’s net cash position in our model and this has increased the price estimate by about $8 per share.
Closing The Cost And Efficiency Gap With Polycrystalline Panels: First Solar’s panels, which are manufactured using a cadmium telluride (Cd-Te) thin-film technology, have trailed polycrystalline silicon-based panels in terms of both conversion efficiency as well as cost. However, the company has made significant strides in bridging this gap during the third quarter, as it was able to reduce its panel manufacturing costs by around 12% sequentially to about $0.59 per watt. This happens to be the largest quarterly cost reduction that the company has achieved in the last six years. These cost improvements could make First Solar’s panels increasingly competitive with Chinese polycrystalline panels which currently sell for about $0.65 per watt.
First Solar was also able to increase the conversion efficiency of its panels by around 0.3% sequentially to 13.3%. As of October, the efficiency for its lead production line touched about 13.9% and the company expects to be able to replicate this efficiency across its other production lines over the next few quarters. ((Seeking Alpha)) Although First Solar’s Cd-Te panels continue to lag behind polycrystalline panels in terms of conversion efficiency, the gap is narrowing and the progress that the company is making remains encouraging. We have increased our gross margins forecast for the company’s solar panels to close to 20% by the end of the Trefis forecast period in addition to marginally increasing our shipments outlook. This impacted our price estimate by around $1 per share.
Other Model Changes: We have also reduced our forecast for the company’s selling and general and administrative expenses to about 26% of gross profits over the Trefis forecast period, in line with current trends, besides marginally reducing our capex estimates to about 28.5% of gross profits by the end of the forecast period. The net impact of these changes on the price estimate is about +$2 per share.Notes: