Thursday, June 17, 2010

First Solar (NASDAQ:FSLR): Upgrading to Outperform - Credit Suisse

Credit Suisse is upgrading First Solar (NASDAQ:FSLR) to Outperform from Neutral with a $150 price target (prev. $110.20). They think the pull-back post earnings appropriately risked the Euro depreciation, but the upside in pricing in Q2/Q3 is not yet reflected in the stock.

Thesis: (i) Upside to estimates: Credit Suisse is raising their CY10 demand estimate from 12.7GW to 13.0GW (cons 10-11GW), strong demand should drive 1Q10 to 4Q10 price erosion < 13%, better than prior model at 17%. (ii) Risks to long-term margins diminishing. “Easy” cost reductions for c-Si namely poly price declines, outsourcing to China and vertical integration have mostly played out – this should stabilize FSLR’s LT margins from CY11. (iii) Long term growth prospects intact. 2011 may not be as bad as feared – German demand could remain strong at 5-6GW as we are closing in on retail grid parity and US demand generally could surprise positively. (iv) Execution: FSLR’s panel efficiencies should inflect meaningfully higher by 4Q10/1Q11.

Catalysts: Expect Intersolar-US to be the next catalyst for the space (July). Credit Suisse also expects that FSLR will at least reiterate its 2010 EPS guidance in its 2Q10 earnings call in July despite the recent declines in the Euro.

Valuation: Credit Suisse is raising their CY10 rev/EPS for FSLR from $2.6bb/$6.79 to $2.7bb/$7.53; street consensus is at $2.6bb/$6.93. For CY11, they are raising teir rev/EPS from $3.8bb/$7.34 to $3.8bb/$8.32. Firm's new price target of $150 represents a 20x multiple on CY10 EPS, consistent with the post-credit crisis NTM multiple of 20x for the stock.

It's a lenghty call (21 pages), so I will summarize some of the more important points:

Margins and pricing for FSLR in 2H10 & 2011

Despite a 10% cut in FiT in Germany on Jan 1 2010, solar panel prices for China based c- Si companies were flattish q/q (in Euro terms) in 1Q10. At the recent Intersolar conference in Munich, Credit Suisse's checks suggested China based c-Si companies are seeing panel pricing trend flat to slightly up q/q in 2Q10 and 3Q10 at ~€€ 1.35/watt in spite of another 16% cut expected in German FiT in July ’10. The possibility that pricing can remain flattish despite two large FiT cuts in Germany has puzzled investors. All too often, the knee jerk reaction tends to be to think that panel prices will take the brunt of price declines when there is a FiT cut in a particular market. However, the mechanics can be somewhat more complicated than that.

There are seven levels of the supply chain that are involved, all trying to capture their (un)fair share of profits from the value of a system. Credit Suisse thinks the investor, who is the end consumer of energy, has the least differentiated value proposition.

The investor in theory is indifferent to the fact that it is a solar installation – the investor is likely comparing alternatives to his money to invest in other activities besides solar. If you assume an 8% IRR is sufficient to attract investment capital, then they calculate that the investor can tolerate up to a €€ 62c/watt increase in system price and still choose to invest in the solar system.

The distributor is the next level in the value chain. Distributors today are earning 25% gross margins, which the firm thinks is significantly in excess of “normalized” gross margins. For example, ARW, a major tech disty, had average gross margins in the 10-15% range over the last 7 years. Thus there can be ~€€ 25c/watt of excess margin that can be squeezed from the distributor chain.

The module maker is the next level of the value chain. Increasingly, the module maker is also the cell and wafer maker. For example, if TSL sold panels at €€ 1.33/watt today, they would get a combined gross margin of €€ 13c + €€ 14c + €€ 13c for each step in the value chain, for a total of ~25-30% GM, which is indeed close to the gross margin for TSL. There can be some margins that the module player needs to give back – but will be a market driven process by which the module players negotiate that price decline with distys, also influenced by the IRRs negotiated by installers and investors.

In summary, while there are valid arguments as to why panel prices could collapse in 2011, there are also opposing arguments as to why it need not decline much more than 10%. For FSLR, Credit Suisse is assuming price declines of 13% from 1Q10 to 4Q10 in USD terms (and 12% in Euro terms) and another 7.5% q/q in 1Q11.

- Long term margin outlook stabilizing for FSLR

Competition with Chinese crystalline silicon based companies was the key reason Credit Suisse downgraded FSLR a year ago in 2Q09. While there are still risks, they note that the bulk of the poly price declines have already played out, as poly prices have already declined from $450/kg at peak in 2Q08 to $50-$55/kg today. There is still some residual risk that pricing drops – they expect to ~$40/kg, but clearly they do not have as much risk as the firm had a year ago for poly price declines. In addition, it appears that FSLR has managed to price its products almost at parity with China c-Si prices. One argument is that FSLR should get a lower price because of lower efficiencies (kWh/area) – however, note that European panel producers get a €€ 40c/watt premium today to Chinese panel prices – relatively speaking, FSLR’s prices are still at a discount. Also, FSLR’s panels produce more kWh/kW (~5-10% more) than poly c-Si, and are also more bankable, which can support a more stable pricing outlook.

Efficiency – the next frontier for cost reductions

Indeed as the c-Si companies start running out of ideas to lower cost, they have gradually started to talk more and more about investing in new technologies such as “selective emitter” to increase efficiencies.

LDK, JASCO, TSL, STP, YGE have all made comments re: making higher efficiency cells.

Credit Suisse does not think it is merely a coincidence that all these companies have rather abruptly started to talk about increasing efficiencies for PV panels. It is much more likely that the “easy cost reductions” are mostly done and will not help as much in 2011; opex does not yield itself well to savings on a per-watt basis as the market diversifies geographically;

While talking about higher efficiencies is a new fad for many c-Si companies, FSLR has consistently maintained that it can increase efficiencies for CdTe panels, to as much as 14% by 2014. However, FSLR’s actual panel efficiencies on the contrary have remained in the 10.8-11.0% range for the last 6 quarters. It is not that FSLR has not been trying to increase efficiencies – Credit Suisse thinks the company is rather waiting for a more opportune moment to bundle several efficiency improvement steps to release to production. They think that it is becoming increasingly likely that we see a 50bps efficiency improvement, at some point by the 4Q10-1Q11 timeframe. They think that FSLR is working on improvements to glass (transparency and light trapping), CdTe film performance, and contacts to CdTe.

Notablecalls: Well, this looks to be a fairly significant call from Credit Suisse's Solar Energy team:

- First Solar (FSLR) seems to be in a position to gain market share as poly prices eventually rebound & the co can start their own efficiency push.

Looking at the polysilicon market, prices are down 90% from their peak. I can say, based purely on experience that if something falls 90%, it's bound to bounce at some point. Makes me think if buying MEMC Electronic (WFR) is the prudent thing to do here...

- The situation in Europe (ex. Spain) does not look that terrible. Germany looks strong!

- The co can squeeze out higher margins from distys. That's not something that can happen overnight but is more of a gradual thing.

- Short interest stands at close to 25% and the stock is still down 30 pts from its recent highs.

All in all, I think FSLR can trade up today by as much as 4-5%, putting $123-125 levels in play.

PS: Did you see how (NASDAQ:PCLN) reacted to that Goldman Sachs upgrade (Buy, $240 tgt) yesterday? The thing went up 10+ pts. That's a tell!


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