FSLR - First Solar: Growing Capacity Valuation Remains Fair (Rating Upgrade)

2023-06-22 08:00:41 ET

Summary

• Global solar demand is safe and is projected to grow at a decent pace.
• As a fully-domestic producer, FSLR benefits from IRA not only in terms of OPEX compensation but also remains attractive for customers, so won’t really be affected by competition.
• Capacity expansion plans are clear; production and revenue will significantly increase in the middle term.
• Government grants almost fully cover high production costs, making the company profitable even under high ramp-up and R&D costs.

Investment Thesis

First Solar ( FSLR ) development looks promising as company expands its production with a decent pace, while costs are mostly covered by government grants. Recent purchase of Evolar was positively accepted by the market, but we believe that investors should wait for further management messages, because how new technology will impact production & financials is yet uncertain. Further positive is mostly included in the market price & according to our valuation, current upside is 27%, so we set a #HOLD status on FSLR and seeking for a more attractive entry point.

Macro is clear, and the competition isn't problem at all

Worldwide solar energy demand remains high, lots of capacities are to set in the nearest several years. According to SolarPower Europe, total capacity expansion will total 341 GW (+42.6% y/y) in the base case scenario and the expansion will continue in 2024-2027 as the part of energy transition policy. Solar remains one of the most efficient alternative energy sources by now, so we believe that demand is safe.

US demand at the same time is heavily depend on government politics and we saw a huge decrease in orders in 2022, when investment tax credits were paused. Anyway, Inflation reduction act has extended both production and investment tax credits, protecting medium-term demand. Wood Mackenzie agency has forecasted that PV installation in 2023 will increase by almost 50% y/y, up to 30 GWdc.

Under the Inflation reduction act, domestic panels remain the most attractive from the terms of tax credits both for producers & customers. Under such market conditions, First Solar won't really experience any competitiveness issues, so we believe the revenue now is only dependent on company's ability to expand its capacity and shipping schedule.

Capacity expansion plan is clear

First Solar's revenue totaled $548 mln (+49.4% y/y) in 1Q, significantly down from our forecast of $747 mln. The large discrepancy was driven by delivery timing, while the production of modules is rising: the company produced 2 526 MW (+21.5% y/y) of modules in 1Q, slightly up from our expectations for 2 394 MW. But it sold just 1 939 MW (+51.0% y/y), shipping some of the manufactured modules to its distribution centers, which shifted revenue receipts to a later time.

Other than that, the company continues to develop in line with our expectations: First Solar started production of Series 7 modules in India in 1Q, which will have a positive influence on the average selling price ((ASP)). The company continues to invest actively in its Ohio and Alabama plants and expects them to start operation in 2024. We have made adjustments to the module sales forecast for the following reasons:

• The updated schedule for new capacity to start operation
• A faster observed expansion of production capacity
• Shift of delivery timing from one quarter to another

Therefore, we are raising the forecast for module sales from 11.1 GW (+7.9% y/y) to 12.3 GW (+17.7% y/y) for 2023, from 14.7 GW (+33.0% y/y) to 16.5 GW (+33.3% y/y) for 2024 and from 18.0 GW (+22.1% y/y) to 19.1 GW (+16.0% y/y) for 2025.

In light of the increased forecast for module sales, we are raising the forecast for First Solar's revenue from $3 343 mln (+28% y/y) to $3 518 mln (+34% y/y) for 2023, from $4 022 mln (+20% y/y) to $4 593 mln (+31% y/y) for 2024 and from $4 868 mln (+21% y/y) to $5 247 mln (+14.2% y/y) for 2025.

At the same time, FSLR has announced its acquisition of Evolar AB as a part of its expansion in Europe. According to Evolar, its technology allows producers to increase PV capacity up to 25%, but we believe as FSLR's CadTel panels are already highly efficient, compared to widely popular crystalline silicon ones, so using Evolar's technology won't bring instant effect on production technology. M&A valuation is cheap - only $38 mln, which is generally immaterial for First Solar. Additional R&D costs are expected to total $2-4 mln.

We believe analysts should wait for further management announcements before making assumptions after M&A announcement, because integration of perovskite in CadTel panels for boosting its capacity now remains uncertain.

Government grants are covering most of the expenses, already making company profitable

From a profitability standpoint, we continue to view the company positively due to the benefits for domestic solar panel producers, which make the company almost immune to the accelerating inflation of costs. But we have slightly downgraded the potential for the expansion of margins in 2023-2025. The company continues to incur ramp-up costs when it opens new plants and upgrades existing ones, such as the one in Ohio, which will continue to have a negative effect on gross profit margin. Additional R&D expenses won't have material impact on margins.

We are lowering the forecast for FSLR's gross profit margin from 48.53% (+15 pp y/y) to 44.55% (+10.12 pp y/y) for 2024 and from 53.68% (+5.15 pp y/y) to 50.70% (+6.15 pp y/y) for 2025 due to the stronger impact from related costs on the ramping up of production. The forecast for 2023 remains at 34.43% (+31.75 pp y/y).

Because the effect of the increased revenue forecast outweighs the effect of the lower margin forecast, we are raising the forecast for adjusted EBITDA from $1 109 mln (+2 307% y/y) to $1 148 mln (+2 391% y/y) for 2023, and from $2 003 mln (+81% y/y) to $2 063 mln (+80% y/y) for 2024.

Valuation

We are evaluating FSLR price based on discounted at 13% EV/EBITDA 2025 multiples method. For the valuation purposes, we're also projecting free cash flow and accounting it in projected net debt. The fair value price for the stock is $244. Target price depicted below is not discounted. We raised our price target from our previous article .

We are evaluating the company by its projected results in 2025, when most of the manufacturing capacity will come online. The target price of $244 was achieved by discounting the price of 2025 at the rate of 13% per annum.

Conclusion

Given that subsidies to producers under the Inflation Reduction Act will be reflected in the company's gross costs, First Solar is fully resolving its issues related to the high production costs of solar panels. Because the law will be in effect until 2027, and demand for solar panels, with all else being equal, will be supported by tax credits that will be made available to buyers (which is especially appealing at a time when the corporate income tax rate rises to 28% starting from 2024), First Solar's financial results become almost completely protected and to a greater extent depend on the pace of putting new capacity into operation.

To manage the position, we suggest keeping an eye on financial statements of FSLR and its competitors and industry research (e.g. EIA, IRENA, Wood Mackenzie).

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