First Solar FSLR is well positioned to capitalize on worldwide solar energy growth, especially in the United States, where state policies and corporate demand are creating a large market. But management’s ability to maintain efficient operations, leading technology, and good customer relationships will determine whether investors benefit from this growth potential.
First Solar has used a slow and steady approach to become the world’s leading manufacturer of cadmium telluride, also known as thin-film, solar panels. Demand is so strong that First Solar already has contracted out two years of its current production capacity.
Solar module makers like First Solar differentiate themselves on cost and efficiency rate--modules’ ability to turn sun into electricity. First Solar has long been a cost and efficiency leader with its thin-film panels. But the more common silicon-based panel technology is catching up.
First Solar must stay ahead of a large pack of competitors by continuing to reduce panel costs and increase efficiency. This will require First Solar to invest continually in new technology and production capacity. First Solar's transition to Series 6 modules in 2017 is the first big transition. Strong demand for Series 6 and First Solar's ability to convert its existing production capacity smoothly is a win for investors so far.
First Solar's concentrated business is a slight concern, especially as rooftop solar gains traction. The company's systems business is a slight drag on margins and has lumpy cash flows, but we expect this business to shrink as First Solar focuses on third-party module sales. We think there are enough sophisticated developers in the market that First Solar doesn't need to be in that business anymore.
If First Solar can maintain its module efficiency advantage and continue its sales momentum, shareholders should realize solid returns. However, we expect First Solar will have to innovate constantly to stay ahead of competitors chasing the fast-growing solar market. We think selling its joint venture yieldco, 8point3, in 2018 was a good move since its cost of capital advantage had eroded.
Although First Solar has a leading solar panel technology and a bright near-term outlook, we don't have confidence it can sustain its near-term advantage over 10 or more years, which is the threshold for an economic moat. The firm faces stiff competition from inside and outside the solar industry as the renewable energy landscape becomes more competitive. We expect First Solar to continue focusing on the U.S. and European markets, not China, where its competitors operate. First Solar's 12.4 gigawatts of bookings and 8.1 GW pipeline are primarily projects in the U.S.
Total solar project costs have fallen toward parity with some conventional generation sources, and stiff competition has developed throughout the solar development value chain. The rapidly increasing worldwide demand for renewable energy has created a race to the bottom among solar manufacturers, financiers, and developers. As such, we do not believe any solar module manufacturers or developers possess economic moats.
The major question is how First Solar's cadmium telluride technology will fare versus the more common silicon-based modules in the long run. First Solar's technology still has a slight edge on the silicon competition, but silicon technology is catching up as more investment flows into the industry.
Even if First Solar maintains its module efficiency advantage with its Series 6 modules in the short run, competitors can achieve lower project development costs by reducing costs elsewhere in the value chain. Although First Solar appears to have competitive systems and costs throughout the value chain, these advantages are not sustainable. Assembling systems is relatively easy work for any general contractor, one reason First Solar decided to exit the system construction business in 2019.
In the long run, First Solar will have to continue investing in research and development to stay at least on par with its competitors. This will be cost-intensive and likely be the key consideration with respect to First Solar’s ability to sustain accretive earned returns on capital in the long run.
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