Tuesday, March 23, 2010

First Solar Flies Too Close to the Sun


MARCH 22, 2010

By PETER EAVIS, Wall Street Journal

First Solar's reign as the sun king could be coming to an end.

The Tempe, Ariz., company has long stood out from its peers in the solar-panel manufacturing sector. Not only is First Solar's balance sheet sturdier than rivals', but its panels are cheaper, resulting in enviable profit margins and revenue growth. Trouble is, the picture darkens over the next few years. Solar power relies almost completely on subsidies, and those are being slashed in Germany, where First Solar made 65% of its sales last year.

Arguably, the company's stock, down more than 40% in two years, already reflects the subsidy cuts. But investors should remain cautious for two reasons about First Solar, which trades at 19 times estimated 2010 earnings. First, the company may find it hard to remain as competitive on cost, because rival-technology panels are falling in price due to oversupply from places like Asia. Perhaps more important, the company may find it hard to support profits by expanding its "systems" business—attracting outside money to help fund solar farms that use First Solar's panels.

In particular, skeptics ask why First Solar needs to expand the systems business. Surely, if solar demand is truly robust, the company should be able to stick to its proven business of making and selling panels, while letting others bear the full project risks. Perhaps few investors want that risk, because they are unimpressed with solar power's underlying economics. If that is the case, it hardly bodes well for First Solar's expansion.

The company's supporters say the economics aren't bad. And First Solar, with its expertise and strong balance sheet, is more robust than other project developers. However, the economics deserve closer scrutiny, particularly in a big market like the U.S. First Solar has negotiated large power purchase agreements—which are signed before a plant is built and typically before outside investors commit—for selling electricity at around 15 cents a kilowatt-hour. That doesn't look obviously attractive, given that, in Germany, solar electricity gets sold above 35 cents a kWh. The company says the main reason it can still make profits at the lower sales price is that key U.S. states have far more sunshine than Germany.

And investors have to keep a close eye on the extent to which First Solar is putting its own money behind new solar farms. If it overstretches, concern will grow it is sacrificing balance-sheet strength for sales. First Solar says it won't put any of its own capital into building larger plants, which means those that exceed roughly 100 megawatts of capacity.

So, where might First Solar trade if issues like these cause earnings to disappoint? Analysts have slashed 2010 estimates to just over $6 a share from $8.53 eight months ago. If that comes down to $5, and First Solar trades at the wider market multiple of 15 times, the stock would be at $75, or down a third from current levels. That would be a decidedly unsunny outcome.

Write to Peter Eavis at peter.eavis@wsj.com

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