First Solar's (FSLR -3.36%) business has changed a lot in the last three years as it's unrolled large parts of the once vertically-integrated solar company. An asset ownership business was sold, the company exited EPC (engineering, procurement, and construction), and it's now looking for alternatives for the U.S. development business while selling the operating and maintenance (O&M) business.
Given all of these changes, what will First Solar look like a year from now?
First Solar is shrinking its focus
A big change over the next year will be the sale of the O&M business, which is being sold to NovaSource Power Services in a deal expected to close later this year. On top of that, First Solar is also evaluating "strategic options" for its U.S. project development business, which normally means looking for a buyer for it.
A year from now, First Solar may have sold its O&M and development businesses in the U.S., shrinking its focus primarily to solar panel manufacturing and a small number of systems projects internationally. The renewed focus for the company looks like it's the right move strategically as companies modularize and specialize, but it could change First Solar's investment upside.
What happens if solar modules are all that's left?
If First Solar's focus is going to be on solar panel sales, investors should consider what the business will look like given the smaller footprint. With guidance of 1.8 gigawatts (GW) to 2.0 GW of shipments in the fourth quarter, First Solar will have about 7.6 GW of production capacity going into 2021. Factories have been running at over 100% capacity, so it's not clear what the real run rate of production will be next year, but that's a good proxy.
We also know that gross margins have improved as First Solar has gone down the path of specialization. So it wouldn't be shocking to see gross margins between 25% and 35% a year from now. But revenue may also be lower since solar panels sell for as little as $0.20 per watt, implying revenue of less than $2.0 billion annually based on current production levels. The higher revenue you see below is because of the systems business, which is being de-emphasized or sold.
So First Solar may be a smaller, more profitable business on a percentage net margin basis. That's great for a smaller business, but what will First Solar do with its profits and the $1.2 billion to $1.3 billion in net cash that's expected to be on the balance sheet at the end of 2020?
Cash is both an opportunity and a challenge
Given the smaller segment of the market that First Solar is going after, it's going to have a lot of cash without many places to invest it. Cash can be great as a cushion, but if a company runs out of places to invest newly generated cash, it's not a good sign for long-term growth.
The options for cash are somewhat limited given the parts of the solar business First Solar has sold off or exited in the last few years. So I don't see acquiring a development business, inverter manufacturer, or EPC or O&M company in the cards. But we could see it expand manufacturing.
If the company continues to generate strong margins on solar panel sales, and the solar market globally continues to grow, it makes sense to expand production. Management talked about this on the third-quarter conference call and expanding closer to customers, bringing to market new technology, and even where the order book stands is going to play into the decision to add capacity.
Given the current solar industry growth, I think a year from now First Solar will have announced an expansion in one form or another. That sounds great, but remember that production expansion and oversupply from solar manufacturers has been what's led to the industry's financial troubles over the past decade, so sometimes growing production doesn't pay off.
Can First Solar stay ahead in solar energy?
I like what the solar industry has done in focusing on small segments of the market that each manufacturer can do well. That'll help lower costs across the industry and make the technology more cost-effective versus fossil fuels long term.
But First Solar is constantly fighting against improving silicon solar cells and low costs from competitors. And that pressure isn't going to stop, which is what makes me leery of buying this solar energy stock that's shrinking, not expanding, its addressable market right now.