Is First Solar Really Falling Behind in Solar?

Yesterday, Goldman Sachs downgraded First Solar (NASDAQ: FSLR  ) to a sell and the stock plunged as a result. Analysts argued that First Solar's position as a builder of utility-scale solar projects will see falling profits and lower growth than companies like SolarCity (NASDAQ: SCTY  ) , which dominates residential solar.

But is this really a dying company, or is First Solar a company to bet on for the long term? Let's take a look at where the company stands.

Is residential solar the future?
Goldman, and the market in general, prefers residential solar to the utility projects that First Solar builds now. SolarCity is a market darling, and with installation growth of up to 90% expected next year the market will remain hot. But does that mean the utility solar market is dead?

Workers build the 21 MW Blythe Solar Projects in Blythe, CA. Image courtesy of First Solar.

The fact is that more than 2.5 times as much utility-scale solar was built as residential solar last quarter and utility-scale solar costs 57% less than residential solar. On a cost basis, residential solar isn't competitive with the grid in the U.S. without tax incentives, and utility solar is.

First Solar signed a power purchase agreement to sell solar power in Arizona for 5.7 cents per watt, well below the grid price. SunPower (NASDAQ: SPWR  )  announced a California project more than a year ago for 10.4 cents per kW-hr and plans to build a 70 MW solar project in Chile that will sell its power straight into the grid, without subsidy. That's where First Solar bought a 1.5 GW pipeline of projects last year; the company no doubt has plans for its own merchant solar projects.

So utility-scale solar is a larger business than residential solar, and it's cheaper to build, but the biggest advantage in my eyes is that First Solar can monetize projects immediately. SolarCity and SunPower, which also finances residential solar installations, want us to believe that these projects will be more profitable on a per-watt basis over 20 years, but there are a lot of unknowns such as panel performance, maintenance costs, and renewal value. First Solar sells projects once they're completed, and we know what the value is immediately. That transparency has to be worth something. 

Will First Solar fall behind?
To answer whether First Solar will fall behind residential solar competitors, you have to consider the future of residential solar. Right now, SolarCity dominates the industry and can generate around $2 per watt of retained value on installations that cost about $3 per watt to build. That's a 40% margin if SolarCity's retained value numbers are true, much higher than homebuilders, finance companies, and appliances or any other product for your home.

One reason margins can be that high is because there are relatively few competitors, and those that exist don't offer the complete package SolarCity does. It can sell a project, install it, and monetize tax credits more efficiently than anyone else. But will that always be true?

I'd argue that over time, residential solar competitors will emerge and consumers will become more educated on the cost of solar and demand more competitive prices. Once the investment tax credit goes down in 2017, there's no reason to think the share of projects installed via leases won't fall significantly from roughly 90% today. In a few years, why not get a loan and own the panels to reap the benefits of solar rather than being locked into a lease for 20 years? SolarCity's own numbers show that system sales come with a roughly 23% margin, well below leases and probably more in line with what I think we'll see long term.  

In other words, even SolarCity's margins will come down over time, something we've already seen happen at First Solar. Residential solar will grow more than utility-scale solar, but it won't always have incredibly high margins and doesn't generate the same immediate value of utility-scale solar. 

First Solar isn't going anywhere
Utility-scale solar is by far the lowest cost solar energy available, and First Solar is the industry leader by a healthy margin. There's no doubt that the company has challenges ahead in improving its technology, but backlog is up 100 MW through the third quarter and First Solar is far more profitable than anyone else in solar.

What's hot today in solar may not last forever. The residential market was on fire a year ago, but it may not be next year as competitors like SunEdison, Sunrun, SunPower, and Clean Power Finance grow in scale and become more competitive.

I'm not suggesting that First Solar is the next solar growth stock or that it won't see margins decline in the future. But the stock trades at 10.6 times trailing earnings and has a long history as a profitable solar company. That's not a position I'd bet against, especially when there are so many questions on the alternatives.

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