Not long ago, First Solar (NASDAQ:FSLR) was on the top of the solar world. The company's stock price had risen to over $300 per share, net income exceeded $300 million annually, and its cost lead over polysilicon rivals seemed impenetrable.
But when China built too much solar capacity in 2010 and 2011 it became a race to cut costs or die, leaving nothing but the lowest-cost companies in the solar market. This price war eroded gross margins that once topped 50% at First Solar, crushing both profits and share price.
Can the company turn things around, and is First Solar stock a value or a dud for investors?
Thin-film modules fall further behind
First Solar's thin-film modules once held a comfortable cost lead over the competition. Today, that lead has evaporated and many Chinese manufacturers are manufacturing panels at lower costs than First Solar.
The reason that's of concern is that Chinese polysilicon modules are higher efficiency, meaning installers can pack more power into less space and save costs on installation costs. Trina Solar's (NYSE:TSL) multicrystalline panels range from 14.3% conversion efficiency to 16% and Yingli Green Energy's (NYSE:YGE) are 14.4%-15.6% efficient. That compares to 13% average conversion efficiency for First Solar; monocrystalline panels are even more efficient.
The acquisition of General Electric's (NYSE:GE) solar business may help a little but GE didn't give up on its own thin-film solar plans for no reason. It saw that it couldn't compete against low-cost Chinese panels with a less efficient solar product. Unless First Solar can increase the pace of cost cutting or rapidly increase efficiency there's simply no reason to keep the module business alive. Even when considering that thin-film performs better in low-light conditions it's not worth the added cost when panels are 10% less efficient than equally priced ones offered by competitors.
First Solar's competitive advantage
Where First Solar still holds a lead is in the project business, but that's a tenuous position right now. The company came into 2013 with 2.6 GW, or $8.0 billion, in project backlog but had just 2.2 GW, or $7.6 billion, in backlog on Aug. 6. It also has had to rely on acquisitions to add to that backlog. In January the company bought a 1.5 GW pipeline of projects from Solar Chile and bought another 1.5 GW pipeline from Element Power earlier this month.
The challenge now is that First Solar dominates in utility-scale solar, but as solar develops it is becoming clearer that residential and commercial solar will be the growth engines in the U.S. and Japan, two of the world's largest markets. There are still opportunities for utility-scale solar but, based on the falling backlog, its momentum is slowing.
Is First Solar stock a buy?
It's hard to argue with First Solar's balance sheet, with $1.3 billion in cash and marketable securities versus $309 million in debt. After generating $168 million in free cash flow last quarter, the stable balance sheet is getting better, for now.
First Solar's problems are more strategic than immediate. Costs for all of its major competitors' modules are falling faster than First Solar's own costs and the company makes a product with inferior efficiency that is only viable in utility-scale projects, not the growing residential and commercial market. I don't think acquiring GE's thin-film technology will make a major difference either.
What is scary for the company is the next generation of polysilicon equipment that will hit the market. Equipment that will allow low-cost manufacturing of 20% or greater efficient panels should be introduced in the next year or two, and then First Solar will fall further behind. The only way to keep up in the panel business would be to build out its TetraSun technology, acquired earlier this year. But that's risky and would cost hundreds of millions of dollars to build at scale.
Foolish bottom line
First Solar is in a weak strategic position and in need of major technology changes just to keep up in the solar panel business. If the company jettisoned its module business and specialized in solar systems the stock could become a value, but not in its current state. I think financials will continue to deteriorate until First Solar realizes that its advantage is in building solar projects, not building the panels that gave it an advantage in the early 2000s. Those days are long gone.