First Solar (FSLR 0.30%) stock has now gone to levels we haven't seen since nearly a decade ago, when the solar industry was just in its nascency. Today, solar energy is a more mature business and First Solar remains one of the leading manufacturers in the industry. And its financial and stock performance is starting to show that position.
As we digest First Solar's third-quarter earnings report, there are a few factors that I think investors need to keep in mind. How these factors play out will determine if First Solar is a great solar energy stock to hold long term, or if it's headed toward another cyclical downturn.
What you need to know about solar system sales
Management said on the Q3 2020 conference call that system sales accounted for 54% of the $928 million in total sales, and brought with them a 33% gross margin. These are both impressive figures, but they should be understood in the context of the business long term.
First, system sales as a percentage of overall sales will likely decline in the next few years. First Solar is looking for strategic alternatives (often code for selling) for the U.S. project development business and selling its North American O&M business.
It's also not safe to assume that economics for system sales will be this strong. Historically, system sales have been very volatile, and right now margins are high because interest rates are extremely low. That could easily reverse course and generate much lower, or even negative, margins in the next few years.
What you need to know about solar panel sales
First Solar's real focus is on the solar panel manufacturing business, especially now that its Series 6 modules have been launched. Panel sales accounted for 46% of sales and generated a 30% gross margin. But there are some caveats to that number.
Gross margin was positively impacted by how First Solar accounts for warranty and recycling costs. When adjusting for one-time items like these, gross margin was 25%, an impressive figure but about in line with what other solar manufacturers are reporting in 2020.
Management guided for 27% to 28% module segment gross margin in the fourth quarter, so results could still improve. But let's keep in mind that both system and solar panel margins had some one-time benefits that aren't sustainable long term.
What does the quarter mean for First Solar long-term?
Even with these one-time items in mind, First Solar had a great quarter. A 31.6% gross margin overall on $927.6 million in sales is impressive, and so is earnings of $1.45 per share. But long term we need to see solar panel margins continue to trend higher, and First Solar to even expand manufacturing capacity if global solar demand continues to grow.
I worry that there could be another cyclical downturn that will affect all solar manufacturers in the near future. But with interest rates low and solar energy becoming more competitive every day, this is a great time for First Solar to improve profitability and entrench itself as an industry leader.