Sustainable Investing

Kirk Spano

"World's Next Great Investing Columnist" --MarketWatch

Your Debt-Free, Profitable First Solar (FSLR) Stock

Since we rolled out FATrader, like several other analysts, I have made the case that the world is changing at an accelerating pace. No longer should we expect technology to take decades to change industry. Machine learning, human experience and social attitudes of younger generations are moving the needle faster each day.

I have also discussed that climate change, whether you believe it or not, is affecting government policy. Part of my 4-step approach to analyzing potential investments is to assess how government (and central bank) policies might impact a sector or company. In the case of energy, global policies are moving in favor of alternative energy and away from fossil fuels.

I have also covered how the fossil fuel divestment movement is growing quicker than expected and affecting share prices for coal, oil and gas stocks. Norway, for example, gave us a list of 134 oil and gas stocks targeted for $7.5 billion worth of divestment. That pressure is difficult to overcome for investors in those same companies.

In coming decades, the great fortunes will be made in the industries that change the most. Energy will possibly be where change is most impactful. It is likely that mankind cuts its carbon footprint at least by half in the next 20-30 years and possibly more. The U.K. is dramatically cutting carbon output right now by simply replacing coal use.

Over the rest of this year, I will give you one stock each week, that is worthy of your research time and consideration for your long-term portfolio. Eventually, we will talk about trading options around the edges of your core positions to enhance your gains and cut your risks.

Today, I will discuss the first solar stock that you need to consider for your portfolio. A debt free company that is leading the way in utility scale solar development.

Changes To U.S. Energy Infrastructure

At the core of the changes coming to energy, will be those within the energy infrastructure and at utilities. The EIA already tells us that new build wind and solar power generation are producing 100% of “net new” electricity generation.

While natural gas fired power plants are currently replacing about 60% of retired coal fired power plants, all newly needed (demanded) power generation, is in fact being supplied by alternative energy.  Alternatives are also replacing about 40% of retired coal fired power plants.

Currently, wind and solar are the dominant forms of new alternative energy production. Wind capacity currently outranks solar 2 to one, however, installations for solar are accelerating much faster. Soon, solar capacity will exceed wind.  

The EIA projects that renewables will be the fastest growing source of electricity generation in coming years. Specifically, solar and wind, will be the fastest growing going forward. Utility scale solar is expected to grow 10% in 2019 and 17% in 2020 compared to wind’s 12% in 2019 and 14% in 2020.

The overall share of total electricity generation for wind and solar will grow from 10% of total in 2018 to 13% by 2020. While electricity generation is growing at a snail’s pace now in America, as more electric vehicles hit the road, 5G – which needs new power generation – is deployed, and more computing power is needed, electricity needs will grow.

In addition, renewable portfolio standards are being implemented in 29 states and the District of Columbia. In these jurisdictions, minimum shares of electricity are being required from renewables.

 

You can see that states are moving dramatically towards more alternative energy. While some might still whine about certain states being “too liberal” or being in the “cult” of climate change, the reality is that the transition is enormously good for their economies.

The transition to alternative energy is simulative to state economies during the buildout phase. It also offers greater long-term energy security, which in turn lures more industry, once again stimulating their economies.

The massive move towards alternative energy that states envision, can only be achieved by having utilities convert away from fossil fuels.

Building Utility-Scale Solar

Utility scale solar is now the most efficient way for most utilities to meet alternative energy requirements. It is also the most efficient way to generate power overall, having become cheaper than coal and natural gas during peak use hours – daytime – in the past couple years.

The argument that solar is too expensive is no longer a reality. In a recent study, using data from FERC (Federal Energy Regulatory Commission) and the United States EIA (Energy Information Administration), not only were new solar and wind builds cheaper than new coal fired power plants. In addition, the study found that building new solar and wind power generation was cheaper than continuing to use 74% of existing coal fired power plants.

What utilities are seeing is the “coal cost crossover” that projections have suggested was coming for the past decade. In most places in America, replacing coal fired power plants, which have slowly increasing costs, with wind and solar which continue to become more efficient, will occur during the 2020s. In other words, it won’t be long before coal fired power plants make no economic sense at all and are retired permanently.

The “natural gas crossover” point is imminent as well, likely to occur in the next several years, as batteries become economically deployable for energy storage. The crossover will occur when batteries can store energy below the hurdle mark of $100/kWh. Already, companies like private NantEnergy are deploying batteries in telecommunications that meet that hurdle. Tesla anticipates meeting that hurdle next year. Larger scale batteries that exceed that hurdle are only 2 to 4 years away.

The growth of utility-scale solar is the proof in the pudding that a massive change is just beginning. According to a study by Wood Mackenzie, growth forecasts for solar development from 2020-22, now exceed the forecasts in place from before President Trump’s solar tariffs.  

Source: Wood Mackenzie

My anticipation is that the “out years” on this chart show a significant increase in projections in a year or two. The wild card for investors is that if Democrats take control of the Presidency, then alternative energy will get a significant boost.

First Solar Leads In Utility-Scale Solar

Most investors think of solar is rooftop residential installs. As the chart above shows, utility-scale builds are the clear leader.

[The problem with residential solar is that existing houses are not ideally constructed, pitched or located for solar, as well as, many homeowners cannot refinance their homes for a typical $10,000 to $30,000 solar and storage improvement. While new residential builds will add solar more regularly going forward, because prices continue to fall and governments mandate it, rooftop conversions remain a hard sell, particularly in cities where sunlight might be obscured.]

One of a handful of companies leading the way in utility-scale solar installations and capacity is First Solar (FSLR).  The company is a leader in utility-scale solar builds, not only in the United States, but globally.  

Here is a quick SWOT analysis before we get into what really differentiates the company:

First Solar Strengths

  • First Solar is the largest producer of thin film semiconductor cells for use in solar systems in the world.
  • The company has expansive global experience working with governments, industry, suppliers and customers.  
  • First Solar is a leader in developing new products. One example is their Series 6 PV modules, which has a significantly higher energy yield and a lower levelized cost of electricity (LCOE) compared to competing technologies.
  • Strong global distribution network that effectively reaches its customers.
  • Highly skilled workforce as a result of investments in training and development.
  • Strong supply chain, which includes reliable raw material suppliers. First Solar is also vertically integrated across the solar value chain.
  • Strong balance sheet with $2.1 billion in cash at the end of Q1, with strategic long-term debt of only $468 million.
  • The company’s Current Ratio is an extremely strong 4.5.
  • Profitable with $1.36 EPS in 2018 (despite Trump).
  • The company’s ultimate industrial strengths are in its experience and efficiency.

First Solar Weaknesses

  • Solar choppiness resulted in negative operating cash flows in recent quarters.  
  • The company is capital intensive, for example, the transition to its new Series 6 modules, is coming with substantial start-up costs. EBITDA margin needs improvement from 12.02%.
  • Transition of its product line to the new Series 6 modules is not complete yet and could cause more choppiness to near-term earnings.
  • The company has low TTM profitability ratios: ROE of 2.8%, ROA of 2.06%, and ROIC of 2.58%.

First Solar Opportunities

  • The strategic transition from older product lines to the Series 6 is nearly complete and could accelerate earnings growth later in the year.
  • Younger generations are supportive of alternative energy and this presents a tailwind from likely public policy outcomes and consumer trends.
  • First Solar can look for opportunities to improve its technology for various products. Continuous innovation can be employed to get higher energy yields from its PV modules.
  • Expansion into emerging markets. There is a clear opportunity in Asia-Pacific (some exposure), as well as, Africa and the Middle East (very little exposure). The company is already expanding work in Australia where it is expected 2/3 of power generation will come from alternatives within a decade.
  • Three-quarters of the company’s bookings are in the U.S. and with accelerating replacement of coal-fired power plants, First Solar can continue to expand their footprint.
  • Governments around the world are changing climate and energy laws to the benefit of alternative energy.
  • Corporations are moving towards alternative energy for cost and energy security reasons.
  • Growth rates for alternative energy among the highest in the world. If First Solar can maintain a slight edge in technology and costs, it can capitalize on industry growth that results in revenue and earnings growth well over 20% for an extended period.
  • First Solar has long been rumored to be a takeout target by oil supermajors and other industrial leaders. Total is already majority shareholder of SunPower, it would not be a surprise to see Royal Dutch Shell, BP, Exxon or Chevron buy First Solar in line with their stated goals of becoming stewards of climate change action (cough).

First Solar Threats

  • First Solar faces intense competition manufacturers of crystalline-silicon solar modules and their Series 6 PV module cannot be guaranteed to maintain a competitive advantage.
  • China is likely to continue subsidizing at lease some solar companies, despite a slowdown, which could negatively impact margins and profitability measures forever.
  • Tax credits for solar installs are likely to shrink over time (the question is probably how fast).
  • PV modules have regularly been oversupplied in the past and that could happen again in the future, reducing This could lower prices for the company's products and reduce revenue.
  • Tariffs could reduce demand for First Solar's products.
  • The demand for the company's products could change based on government subsidies for renewable installations. Reduced subsidies would have a negative effect on revenue.
  • Increased cost of raw materials would reduce margins and lower profitability.
  • First Solar is subject to currency fluctuations as a result of its global operations.
  • The stock can correlate to the price of oil, which creates additional price volatility.

What Is The Market Missing?

At the moment, not much. The stock has rallied dramatically this year, rising over 40%.

The stock is nearly overbought on a daily and weekly basis, with money flow gushing in since late autumn 2018. The money flow accelerated before the market bottomed, indicating strong “smart money” investment.

There is still a lot of skepticism about solar in the market place. This lends the solar stocks to higher than normal volatility. For intelligent investors, the volatility provides attractive entry opportunities. For enterprising investor, the volatility provides trading opportunities.

The stock is likely to retrace a portion of the gains from autumn. Based on moving averages, Fibonacci ratios and where money flows started to sputter, a pullback to around $50 per share seems likely on any market weakness in general or earnings miss on May 2nd.

The likelihood of an earnings miss or something simply not exciting is high in May. Analysts are not increasing their forecasts and that is a harbinger of a pause in the bullish narratives that have supported the stock so far this year.

I have trimmed my First Solar holdings this week, which I bought around $40 per share, but am not shorting the stock or buying puts here. If the share price reaches the low $50s I will be a cash-secured put seller at various strike prices in and out of the money. I am an outright buyer of shares in the $40s.

I do not see any long call leverage opportunities developing until the stock market corrects more substantially. I do not want to be holding calls in the event of an elevator drop event. I think the odds of a Black Swan events have been increasing since last year (if I only knew which Black Swan and when it was coming).

The Short Stories Nobody Is Talking About

The growth story for solar is undeniable at this point. Utility-scale solar is growing at over 20% per year globally and there is likely a higher growth period coming at some phase in the solar buildout. First Solar is an undeniable leader in that market.

First Solar’s EPC skill set, that is engineering, procurement and construction, is second to none in the U.S. There are only a few legitimate competitors when it comes to building out solar power plants. I believe this bodes well for future project pricing. This will be important to improving the profitability measures mentioned as weak above.

To measure whether the company can improve its profitability, we will have to watch future contracts for builds. Investors want to see expenses for the company to fall more than contracting prices do, as that will improve margins. With only a few legitimate competitors, oligopoly pricing could develop driving margins into the low to middle teens.

The tariffs on foreign made solar panels is supportive of First Solar domestically, though retaliation abroad is disruptive. On net, until the U.S. has built out its solar fleet, which will take a decade or more, and First Solar gets more than half their revenues from America, the tariffs benefit them. I expect some sort of protection from foreign panel dumping to be long-lived.

The buyout likelihood for First Solar is high in the next few years. While speculating on mergers and acquisitions is difficult, I make a point of seeking out companies across my investment universe that benefit from strategic transactions, whether that be spinning out companies (I expect Alphabet to have Baby Googles soon), merging with equals or being bought outright.

It makes tremendous sense for Exxon, Chevron, BP or Royal Dutch Shell to buy First Solar. The company is a profitable leader in a fast-growing solar field. It also would add tremendous “street cred” to the notion that the oil majors are truly moving towards being stewards of the climate (cough).

Importantly, the synergies for the oil companies to buy First Solar are rather tremendous. The oil majors own a lot of land. Placing solar on land that is within 20-40 miles of cities and has transmission lines could add a significant source of revenue for a subsidiary of the oil company, which is what I believe First Solar could become.

I believe that the oil majors will have major problems by the end of the 2020s with stranded assets, falling profitability, failing dividends and tighter debt issues. It will not be long before Exxon and Chevron start to look at “unwinding” their upstream, downstream, midstream and other assets.

Creating a “clean company” unburdened by legacy fossil fuel issues, such as litigation we know is coming, for executives and certain assets to escape to is very strategic for them (in a Machiavellian sort of way). There is also the possibility of the oil majors spinning out REITs, which would be interesting, that could include solar farms. The combination of First Solar with an oil major I would handicap as no less than 50% likely.

Ultimately, smart investing requires that we find what the market is not valuing but should be. First Solar has market protection and likely suitors, on top of its advantageous position in a fast growing, governments supported industry. First Solar should be a core holding for any long-term growth portfolio.

Kirk Spano

Kirk Spano covers Sustainable Investing as one of the original contributing analysts at FATRADER. Named the "Next Great Investing Columnist" at MarketWatch, Kirk has been getting the jump on secular trends for over 20 years, and now sees investing in alternative energy, smart grid, EVs, agriculture, healthcare and water as the most likely place to make outsize profits in coming decades.
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