First Solar (NASDAQ:FSLR), the world’s largest player in the thin cell PV segment, has been subject to intense price competition from Chinese manufacturers over the past few quarters. First Solar’s thin cell Cd-Te technology gave the company a cost advantage over its competition, but that has eroded considerably of late mainly because of lower prices across the polysilicon based PV module supply chain. First Solar’s competitors such as Trina Solar (NYSE:TSL) and Yingli Green Energy (NYSE:YGE) use polysilicon to manufacture modules, which makes modules costlier but more efficient than thin cell technology based products.
A global polysilicon glut has resulted in lower raw material costs and Chinese players, with considerable government backing, have slashed prices. We have revised our forecasts for First Solar in light of these changes and our price estimate for the stock now stands at $51 which is about 20% ahead of its current market price. Below we highlight some of the factors that have contributed to our revised outlook.
Increasing price competition
Loaded with debt and inventory, Chinese players have aggressively cut prices since the 2nd quarter of 2011 in a bid to sell their products despite falling demand from European markets. The solar market shake up also impacted the polysilicon production industry, which derives 90% of its demand from PV module manufacturing. Spot prices for polysilicon fell from a record $475 / KG in 2008 to around $33 / KG in Q4 2011.
Raw materials account for 25% of the cost of manufacturing solar modules and we expect prices to fall even further if the downturn continues as industry production is expected to outstrip demand by nearly 30% in 2012. The situation may get worse in the medium term because total industry capacity is set to almost double from its 2011 levels in the next three years. (See: LDK Solar Gets Caught in Polysilicon Glut)
First Solar uses thin cell Cd-Te technology that does not use polysilicon as a raw material. While this technology gives First Solar a cost advantage over its competitors, falling raw material prices mean that First Solar’s cost structure will not come down in tandem with the industry. The company enjoyed gross margins around 50% in 2009 and 2010. Given the present dynamics we expect margins to fall to around 20% by 2014, compared to our previous estimate of more than 30%. These margin revisions accounted for the majority of our price estimate reduction, as photovoltaic modules account for about 70% of our price estimate for the stock.
Company shelves R&D plans
In a bid to reduce costs, First Solar also wound up its development plans for the emerging low-cost copper indium gallium selenide (CIGS) PV cell technology. This move was purportedly sparked by Japanese firm Solar Frontier KK beating First Solar to develop a product using this technology. Shelving CIGS development will impact the long term cost advantage enjoyed by First Solar over its competitors. (See: First Solar Loses Chief Technologist as Company Cuts Costs)
In another development, GT Advanced Technologies – a manufacturer of furnaces to turn silicon into crystalline cubes – announced two new technologies to significantly cut costs of manufacturing for polysilicon-based high efficiency module manufacturers.  This could further reduce First Solar’s cost advantage.
Economic woes in Europe
The demand outlook from Europe still remains uncertain because of a weak growth outlook and the continuing strain on government budgets. S&P recently downgraded the debt of 8 European countries, leaving Germany with the only stable AAA rating in the region. Solar is still dependent on government subsidies from the angle of economic feasibility. Governments are being pressured to reduce deficits and solar subsidies could face further cuts in the future. German’s economy minister Philipp Roesler indicated that the country may consider imposing a cap on solar installations. (See: German December Solar Installations Surge in Race to Beat Subsidy Cuts) Demand from Europe constitutes a major portion of the revenues of PV manufacturers like First Solar.Notes: