First Solar's (NASDAQ:FSLR) recently reported third-quarter earnings contained a lot of what investors have come to expect from the company. Revenue came in better than expected, guidance was increased slightly, and manufacturing upgrades are ahead of schedule. But looking at expectations masks the fact that revenue was down 19% from a year ago, and net income dropped by nearly half. 

Some of the change is due to developing and selling fewer solar farms, but there are always a few red flags you should look for in solar industry results. Here are the top risks facing leading renewable energy stock First Solar, and how the company is trying to overcome them. 

Large solar farm in the desert.

Image source: First Solar.

Solar panels are a commodity

The harsh reality today is that solar panels are essentially a commodity, especially in the utility-scale solar market where First Solar operates. That means there isn't anything the company can do to change the market's natural price fluctuations. But it can try to differentiate its product from those of its competitors, and lock in sales so it isn't subject to the commodity market whims day-to-day. 

As far as differentiation goes, First Solar has invested over $1 billion in upgrading the manufacturing of its Series 6 solar technology. This is still the only thin-film solar panel that's mass-produced, so there's no direct competition from a technology standpoint. First Solar's panels aren't the most efficient in the industry, with 17% to 18.2% efficiency converting the sun's energy into electricity, but they produce energy more of the time than commodity panels.

Thin-film technology produces more energy in high-heat and low-light environments, so that's where First Solar often wins big projects. The challenge is that new commodity technology called mono-PERC is improving efficiency and harsh environment performance for commodity manufacturers, so this advantage is fleeting. For now First Solar is still selling what it makes, but gross margins shrinking from over 50% a decade ago to the mid-teens in 2019 show that First Solar isn't creating a superior product that can command a price premium versus commodity competition.

FSLR Gross Profit Margin (TTM) Chart

FSLR Gross Profit Margin (TTM) data by YCharts

First Solar is doing a good job locking in future sales to ride out some of the ups and downs of the commodity solar business. It has booked 5.4 gigawatts (GW) of solar panel sales in the first three quarters of 2019, compared to 3.8 GW in shipments. It's locking in sales well into the 2020s, and that's great news for the future, even if we don't yet know what margin those future sales will generate. On a longer time horizon, the company is still impacted by changes in commodity solar panel performance and technology, but these contracts will mute the impact if prices fall. 

Policy is key

Like any solar stock, First Solar is dependent on a friendly policy environment to survive. Developers need to have a favorable policy framework, whether that includes subsidies or access to the electricity market to generate demand, or even protectionist policies like tariffs. The Trump Administration recently undid an exemption that had been given to bifacial solar panels, a technology that could have been a threat to First Solar. This policy protection should help the manufacturer's margins over the next two-plus years while the tariffs are in effect. 

Developers are receiving fewer subsidies than they have in the past two decades, but the low cost of solar energy is making solar power plants competitive when they have access to the grid. With states like Florida, Nevada, and Arizona opening up their grids to solar energy, the policy environment is improving, even in the U.S.

Is First Solar coming or going in solar energy?

While First Solar has the best balance sheet in the solar industry and is one of the few companies that's been profitable long-term, it's in a tough position today. Competitive solar panels are getting better and more efficient and undercutting First Solar's pricing. Where it doesn't have protections like tariffs, it isn't winning much business. 

Meanwhile, tariffs on competitors' solar panels are coming down in the U.S., and will eventually be eliminated in early 2022. Companies like SunPower and JinkoSolar are also adding U.S. manufacturing that isn't subject to tariffs. That will limit any financial upside from protective tariffs. 

The one good thing is that the solar industry overall is growing, so the demand for solar panels is rising. But in an industry that has dealt with oversupply and falling commodity prices for more than a decade, the rising tide won't lift all boats, and I see First Solar's risks outweighing its strengths today.