Why We Remain Bullish On First Solar Despite The Recent Selloff

First Solar‘s (NASDAQ:FSLR) stock has declined by more than 15% over the last month or so, owing partly to weak Q1 earnings and some analyst downgrades. However, we believe that the recent sell off is overdone. The stock trades at its book value and is priced at about 16x FY2016 consensus estimates, which is relatively low for a firm in a high-growth industry. Although First Solar faces some challenges in sustaining its margins as it winds down lucrative legacy projects in the U.S., we believe that its longer-term revenue growth should remain reasonably strong, due to its rapidly evolving technology, adequate manufacturing capacity and its move to form a joint-venture yieldco with rival SunPower (NASDAQ:FSLR). In this note, we take a look at three key factors – technology, demand and financing – that are driving our price estimate for First Solar.

Trefis has a $6o price estimate for First Solar, which is about 20% ahead of the current market price.

See Our Complete Analysis For First Solar

 1) Technology: Efficiency Improvements And Energy Yield Advantages

While First Solar’s Cadmium-Telluride panels have historically had a efficiency handicap compared to silicon-based panels, its technology has been evolving faster than the broader industry.  Average panel conversion efficiency stood at 14.7% during Q1, representing a 1.2% year-over-year improvement and a 0.3% sequential improvement.  The conversion efficiency of the company’s best production line grew to 16.3%, slightly ahead of some polycrystalline panels. First Solar expects the metric to rise to about 19% by 2017.  Since Cd-Te thin-film panels have a higher theoretical upper limit for efficiency compared to silicon-based panels, First Solar could eventually have among the highest efficiencies in the industry.

The efficiency improvement has multiple implications for First Solar. Firstly, it should open the doors for the company into the rapidly growing rooftop and distributed solar market, where high-energy density panels are valued. Secondly, it should help to reduce per-watt manufacturing costs. For example, the company noted that the 16.3% efficiency modules have a cost-per-watt of about $0.40 (excluding selling costs), which is well below the cost of most Chinese silicon-based panels. This should help the company continuously improve margins for panels. Thirdly, higher efficiencies will result in significant incremental manufacturing capacity for the company, without having to build new factories, since each module will deliver a higher rated capacity as efficiency improves. Between 2013 and 2015, First Solar estimates that technology improvements will result in an addition of about 460 MW (or 5 manufacturing lines equivalent) of additional capacity.

Separately, Cd-Te panels already have an edge over silicon-based panels when it comes to total energy yield. They perform well under a variety of lighting conditions and also see a lower performance degradation in extremely hot and humid climates, due to a superior spectral response and temperature coefficient. This should provide the company a crucial competitive advantage in high-growth markets such as India, the Middle East, Africa and Latin America , which typically experience high-temperatures and solar insolation.

2) Demand And Capacity: Growing Order Book, Adequate Capacity To Meet Demand

Global solar demand is expected to grow by about 30% this year to about 57 GW, according to market research firm IHS. ^[1] U.S. demand is also projected remain strong through 2016, as installers take advantage of the solar investment tax credit which is slated to decline from the end of 2016. First Solar has noted that it is virtually sold out for 2015 and that its contracted volumes for the next year are also growing. The company’s order book (for both systems projects and third-party panel sales) stood at 3.9 GW at the end of April, an increase of 200 MW from the end of 2014.

Unlike rivals SunPower and Yingli Green Energy (NYSE:YGE), who have been facing capacity constraints, First Solar seems well placed to deal with the spurt in demand, owing to its adequate manufacturing capacity and continuous panel efficiency improvements. As of December 31, 2014, it had 30 installed production lines with an annual global manufacturing capacity of 2.7 GW at facilities in Ohio and Malaysia. It also has about 1.3 GW in stored manufacturing equipment from its former German factories and from other manufacturing facilities that were put on hold. ((First Solar 2014 Form 10-K))

3) Financing: YieldCo Can Reduce Funding Costs And Generate Long-Term Value

First Solar intends to create a joint-venture yieldco – called 8point3 Energy Partners – with rival SunPower. The two companies plan to take the entity public by the end of this year, raising as much as $50 million. 8point3 Energy Partners will have an initial portfolio totaling 432 MW (262 MW of utility-scale projects from First Solar and 170 MW of utility and distributed projects from SunPower) located in the United States and will also have a Right of First Offer (ROFO) for another 1,131 MW of projects. Yieldcos typically help to reduce the costs of equity funding for renewable projects, since they allow investors to single-out cash flows generated by the power generation assets, without exposing them to other aspects of the parent company’s business. The yieldco structure could prove helpful for both companies, since it would allow them drop-down power plants into the yieldco and use the capital raised to fund new projects. This could help to lower cost of capital and improve the valuation of their respective project development businesses. Additionally, since the parent company typically retains a significant stake in the yieldco, it should help to bring in some recurring cash flows in the form of dividends.

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1. Global solar demand in 2015 to hit 57GW on strong 30% growth rate, PVTech, March 2015 [↩]