First Solar: Analyzing the Solar Industry's Potential Amid Recent Dips

First Solar: I'm Buying The Solar Dip Hand Over Fist (FSLR)

Looking for more investing ideas like this one? Get them exclusively at The Pragmatic Investor. Learn More " Solar stocks have taken quite a beating in the last few months. Some of it has to do with fundamental business reasons, while politics has also become an important factor. The current dip allows us to get exposure to quality solar companies, and there is none better, in my opinion, than First Solar (NASDAQ:FSLR). The company has shown great progress in its revenues and earnings thanks to its brand value, superior technology, and strategic partnerships. While challenges may be ahead, I see a great set-up in FSLR, both fundamentally and technically. Solar stocks had a nice rally in 2023, but they have been selling off in the last few months. SolarEdge (SEDG) has led the decline after posting weak Q2 guidance, seeing some of its customers file for bankruptcy and being forced to raise cash and lay off workers. First Solar, while still up over the last year, has fallen over 25% since its peak. Operationally, the company has been doing quite well, which led to a big rally ahead of this sell-off. However, concerns have now emerged over the IRA (Inflation Reduction Act) subsidies the company is benefiting from. FSLR has been the largest beneficiary of this credit and has even been linked to Biden's campaign through numerous donations from management. Investors, following the presidential debate and more recent events, now seem to believe a Republic win is more likely, which could bring an end to the IRA subsidy sooner than expected. The IRA credits are largely responsible for the recent increase in revenue and profits and are driving much higher estimates for the future. But will the Republican win eliminate the IRA much earlier than anticipated? This risk seems overstated. The IRA subsidy is a play on clean energy, which in general terms we could say Democrats favour and Republicans do not, but people forget it is also a play on energy independence and protectionism from China. The IRA protects FSLR from more economic Chinese competitors, while also increasing the energy independence of the country. In today's increasingly fractured world, these are policies that both sides can definitely get behind. While politics have played a big part in this industry, FSLR has also stood on its own merits. The company has done well against its competitors and has set itself apart from the pack in my opinion. Here are the key reasons I like FSLR: First Solar has managed to dramatically increase its revenues and margins in the last few years. The company has increased its gross margin to over 43%, while EBITDA has grown over 1000% in the last year. This is not just strong growth, it's also strong growth when compared to its peers. A large part of this can be attributed to FSLR's superior technology. FSLR used Cadmium Telluride panels, which have been proven to be more efficient than silicon panels. This allows the company to provide higher efficiency to its customers, which in turn translates into better returns for them. Demand for energy is on the rise. It is now widely accepted that energy may become a true bottleneck in the AI revolution, given the large power needs of LLMs. Solar will no doubt become an integral part of the energy equation. In some regions, Solar energy is already proving to be as cost-efficient as traditional forms of energy. The EIA projects solar generation will dramatically increase from here until 2050, reaching over 8 trillion kilowatt-hours. With all that said, it seems like FSLR has plenty of room to grow and expand. This is certainly what analysts think at the moment: First Solar's EPS is projected to increase from $7.74 in 2023 to an estimated $36.74 by 2027. The company's gross margin is also expected to improve substantially, from 39% in 2023 to 64% in 2028, factoring in the advantages of domestic manufacturing tax credits from the U.S. Inflation Reduction Act (IRA). UBS anticipates that First Solar's net cash will exceed $115 per share by 2028. Source: UBS report As we can see, estimates begin to come down in 2028, as the subsidy ends. The IRA subsidy poses a big opportunity or risk. At $300, the stock was priced for the strong growth stated above. Expectations have now shifted. Now, at $200, it could be quite undervalued, especially if the IRA continues. At today's price, FSLR trades at very attractive ratios, especially when we look at PEG. At $200, there seems to be a reasonable margin of safety now, even if the IRA were to disappear tomorrow. I find this unlikely, and even if it does happen, you are still left with a strong company in a growing industry that will likely receive further subsidies in the future. FSLR has now retraced close to its 61.8% retracement of the rally from the February lows. This is an ideal spot for a reversal. We are also just above the 200 EMA, which comes in to offer support at $194. Notice also how we have a bullish divergence in the RSI, and the MACD could be getting close to a bullish crossover. There are still risks associated with FSLR. This is a competitive industry, and it has relied on government subsidies, which are not guaranteed. Without the subsidies, FSLR would also face more intense competition from Chinese competitors. All in all, I think the current sell-off gives us a good opportunity to buy. The fear around the end of the IRA subsidy is overblown, and even without it, FSLR would not be that unattractive. We have a chance to buy now near technical support and when the worst possible case scenario seems to be priced in. This is usually when bottoms happen.

First Solar: Sunny Days Ahead (NASDAQ:FSLR)

First Solar, Inc. (NASDAQ:FSLR) is an American Solar manufacturer headquartered in Tempe, Arizona, with research and development labs in Ohio and California and manufacturing facilities in Ohio, Alabama (expected 2024), Louisiana (expected 2025), Malaysia, Vietnam, and India. With 6 GW of US nameplate capacity, expected to rise to over 14 GW by 2026, First Solar is the largest producer of solar panels manufactured in the United States. With First Solar's leading position as a US solar manufacturer and tailwinds from increased energy needs related to Artificial Intelligence ("AI") and an expected decline in interest rates, I see First Solar's stock being driven higher by significant margin expansion and revenue growth. My base case financial model for First Solar results in a price target of 307 USD per share. In 2022, the US Congress passed the Inflation Reduction Act ("IRA"). Included in the IRA are incentives for the manufacturing of solar panels in the United States as well as the deployment of solar in the US, with additional incentives for deploying solar with "domestic content". First Solar is a significant beneficiary of manufacturing incentives under the IRA. In addition to manufacturing incentives, First Solar benefits indirectly from the 10% domestic content tax credit "adder" realized by developers. To qualify for the adder, projects which begin construction by January 1, 2025, must use at least 40% domestic content. This escalates to at least 55% domestic content for projects which begin construction after December 31, 2026. As solar panels make up approximately 40% of utility-scale solar development projects, solar panels effectively need to be purchased from a US manufacturer to qualify for the adder. In addition to benefits from the IRA, First Solar is well positioned to benefit from increased energy needs to power investments in Artificial Intelligence ("AI"). An explosion in investments in AI has led to increased demand for new sources of power, with Meta CEO Mark Zuckerberg expecting that as AI chips become more available, investments in AI will be limited by the energy needs of AI data centers. According to the International Energy Agency ("IEA"), electricity demand for data centers could exceed 1,000 terawatt hours ("TWh") by 2026. To put that into context, that demand for power, without adding carbon-emitting power sources, would require an additional 127 one-gigawatt nuclear power plants, 121,000 2.5 GW wind turbines, or about 505 GW solar power installations just to support the additional energy needs for artificial intelligence (assuming 0% capacity factor for nuclear energy, 37.5% for wind energy, and 22.5% for solar energy). That compares to just 7.9 GW of nuclear power added globally in 2022, 117 GW of wind power added in 2023, and Bloomberg's NEF expectation for 574 GW of solar power to be added in 2024. That is in addition to accelerating demand for electricity from a global push toward electrification and rapidly growing demand for power in emerging markets. Admittedly, even considering advances in battery storage, solar energy may not always be the best solution for data center energy. Data centers are ideally located in colder regions where solar power may not be as effective as other power sources, but running inference applications at the edge means data centers will need to be in regions subject to weather favorable to solar energy production, and data centers even today are broadly distributed. Furthermore, First Solar is also the primary producer globally of thin-film cadmium telluride ("CdTe") solar panels. Their CdTe solar panels offer an energy production advantage over traditional monocrystalline and polycrystalline solar under sub-optimal conditions. I expect this technological advantage in sub-optimal conditions to be more attractive than competing solar options to power data centers in regions more subject to partial cloud cover. Alongside other companies in the solar industry, First Solar should also benefit from a decline in interest rates and secular trends towards electrification. Community and utility-scale solar is typically financed 90% or more by debt and tax equity. Although cyclical in nature, a decline in interest rates will make both debt and tax equity cheaper, which will make investments in solar projects more attractive to solar developers and drive incremental demand. As a result of the IRA, with First Solar's dominant position in US manufacturing of solar, investments in energy to power artificial intelligence, with First Solar's technology advantage under suboptimal conditions, and with the backdrop of an expected decline in global interest rates, I expect First Solar to realize meaningful revenue growth and gross margin expansion. The primary drivers of First Solar's valuation are revenue growth and gross margins. The primary driver for revenue growth will be increased volumes driven by additional manufacturing capacity expected to come online beginning in the second half of 2024 and a clear roadmap to increase capacity by approximately 52% by 2026, including a 135% increase in domestic manufacturing capacity. Combined with higher utilization rates driven by high demand tied to the Inflation Reduction Act, electrification, and energy infrastructure to support AI, I see First Solar expanding total production from 12 GW in 2023 to nearly 22 GW by 2026. Maintaining average selling prices ("APS") is also a key driver for revenue growth. The company noted year-to-date bookings at 31.3 cents per watt on their first quarter earnings call. If maintained for the full year, that would be a significant improvement over the 29.2 cents per watt realized in the full year 2023. Additionally, the Q1 2024 10-Q noted the compensation committee at First Solar has approved stock grants tied to the company's ability to improve incremental ASPs among other metrics. As Charlie Munger famously said, "Show me the incentives, and I'll show you the outcome". With that in mind, and with tailwinds from the IRA driving increased demand for domestically manufactured solar products, I believe it is reasonable to expect the company to moderately increase ASPs. I expect ASPs to increase to 30.3 cents for the full year 2024 from 29.2 cents in 2023 and reach 32.8 cents per watt for 2026. As noted, the IRA provides significant incentives for companies which manufacture solar panels in the United States. First Solar expects to realize about 17 cents per watt in incentives for components manufactured in the United States, First Solar realizes these credits as a reduction to the cost of goods sold ("COGS"). The company has already seen a significant reduction in COGS from 28.6 cents per watt for the full year 2022 to 16.6 cents per watt in the first quarter of 2024. I expect cost per Watt to fall slightly to 15.2 cents per watt by 2027 driven by increased production at their new US-based facilities. This results in gross margins increasing from 39% in 2023 to 54% in 2027. The recent US Presidential Debates have sparked concern that the IRA could be repealed. Given the popularity of creating US manufacturing jobs, the importance of climate mitigation to the Democratic Party, and with 161 of the 200 billion USD invested under the IRA going to Republican districts, I believe the IRA is extremely unlikely to be repealed. In addition to primarily hurting Republican constituents, repealing the IRA would require the Republican Party to not only win the House and Presidency, but it would also likely require a 60-vote majority in the Senate to break the filibuster and make a repeal of the IRA a legislative priority. The Republican Party has previously attempted to repeal the Affordable Care Act, I believe this is a reasonable case study of what may play out for the IRA. Nonetheless, repealing the IRA would be a significant downside scenario for First Solar. I have included a downside scenario reflecting a repeal of the IRA going into effect for the full year 2027. This scenario also assumes a 60% tariff on Chinese solar panels imported into the United States. This results in a DFC valuation of about 168 USD per share. First Solar's position as the largest domestic manufacturer of solar makes it very difficult to compare directly to other solar manufacturers. The stock currently trades at approximately 21X trailing earnings, compared to 5X trailing earnings for Canadian Solar and 3X trailing earnings for Jinko Solar. Despite operating similar businesses, First Solar operates in a fundamentally different business environment. As a result, I chose to value First Solar based on discounted cash flows. First Solar has relatively low leverage, with about a third of their outstanding debt expected to be repaid within the next year. Most of the debt which will be repaid this year is rupee-denominated and carries a relatively high interest rate. I, therefore, elected to calculate First Solar's free cash flow to equity and discount the cash flows at the cost of equity. First Solar has a weekly five-year beta to the S&P 500 of about 1.06. The S&P 500 has returned approximately 15% per annum over the five-year period ending July 16, 2024. Given the volatility in interest rates and the expectation for interest rates to fall, I used a 4% risk-free rate, which is my longer-run expectation for 10-year treasury yields. This results in a cost of equity of about 12%. Notably, the Street expects the IRA to begin to sunset starting in 2030 and fully sunset by 2032. Under such a scenario, it makes sense to value First Solar using a Sum-of-the-Parts methodology, which values the tax credits separately from the value of the business, excluding tax credits. The Street applies a forward earnings multiple to the earnings less the benefit of tax credits and then adds the net present value of projected tax credits through 2032. In my base case, this results in a valuation of approximately 203 USD per share based on 25 times next year's earnings to 230 USD per share based on 15 times 2028 earnings for an average of 216 USD per share. I have included sensitivity tables reflecting this valuation methodology under different earnings multiples and cost of equity scenarios. As noted, I do not expect the IRA to be repealed. I also do not expect the IRA tax credits to sunset by 2032. According to Wood Mackenzie, unless the IRA is repealed, the IRA could be extended "substantially longer than 2032 - perhaps even 30- 40 years." Both Wood Mackenzie and First Solar noted "Both the ITC and PTC are available until a four-year phase down is triggered, which occurs at the later of 2032 or the year in which power-sector emissions are 25% of 2022 levels." If that is the case, then I believe it is more appropriate to use a traditional DCF methodology to value the company as it seems unlikely that power sector emissions will decline 75% by 2032, particularly given the energy needs of AI, which would not have been a consideration in drafting the IRA in 2022. My valuation of 307 USD per share is an average of my valuation under the perpetuity growth method and the exit multiple method. I assumed a perpetuity growth rate of 3%. My perpetuity growth rate is intended to reflect global GDP growth, which has been between 2% and 5% outside of recessions since 1980. My exit multiple of 15 times earnings is intended to be reflective of an appropriate P/E ratio for a company which is growing at a moderate rate, significantly below First Solar's current growth rate. My valuation under the perpetuity growth rate method is about 257 USD per share, and my valuation under the exit multiple method is about 375 USD per share. The average is 307 USD per share after rounding to the nearest dollar. This represents a premium of about 44% over the closing price as of July 16, 2024. For investors who can go short, consider pairing a long position in First Solar with a short position in a Chinese solar manufacturer that would be hurt by a 60% tariff and isn't benefitting from the IRA.