FSLR - The Impact Of Domestic Content Notification On First Solar And The Solar Industry

2023-05-18 11:47:29 ET

Summary

• Domestic Content Notification from the Treasury Department provides a lax definition for claiming IRA tax credits.
• First Solar benefited because the lax requirements are not as lax as some in the industry have hoped for.
• The clarification strengthens demand for First Solar modules, and there are several ways in which First Solar can cash in on the tax credit.

On Friday, 12th May, the Department of Treasury issued a " Domestic Content Bonus Credit Guidance " notification clarifying the domestic content requirements to claim "domestic content tax credit" per the "Inflation Reduction Act". The intent of domestic content requirements is that this 10% tax credit will incentivize project developers to use American-made components in building solar (and wind) energy systems. The Domestic Content clarification memo clarifies what the US government will consider "domestic content" in evaluating if a specific project is eligible for a 10% bonus tax credit.

The clarification says that 60% of "Manufactured Product" per the Treasury definition, needs to be domestic for the project to qualify for the tax credit. By permitting up to 40% of the "manufactured product" value to be non-domestic, the Treasury Department is essentially saying that about 40% of the solar PV module value can come from non-domestic sources.

While the requirement is clearly lax, this guidance is more stringent than what some industry lobbies were pushing for. Long story short, the clarification, while providing a lax definition of what qualifies domestic content, is a middle-of-the-road solution and per industry expectations.

Implications For The Industry

The most direct impact of this ruling is that project developers will now be able to claim a 10% domestic content credit far more easily than they could with a more stringent interpretation. They can use modules from manufacturers who made the cells and modules in the US but whose polysilicon and wafers originated from China. This allows the developers to claim tidy tax credits without being dependent on 100% domestic manufacturers like First Solar ( FSLR ).

Note that the basis on which a developer claims tax credit is entirely different from the cost of the system. Utility-scale developers, who may only spend $0.90 per watt in developing the system, are likely to claim credits based on a system valuation of well over $1 per watt. For reference, Sunrun (RUN), a residential solar developer, has routinely claimed tax credits based on a $4 per watt system value. For the purposes of this discussion, let us assume that the tax credit is based on a $1.00 per watt system value or about $0.10 per watt in credit. ( Beyond The Hype has no knowledge of the actual range of values but has seen reports in the past of developers claiming over $1.25 per watt when it comes to tax credits.)

A $0.10 per watt benefit on a sub $1 per watt investment is a huge swing in ROI for solar developers. We can expect to see a high amount of creativity in how this tariff will be exploited over time. Some of the impacts will be felt up the supply chain at inverter, module, and tracker manufacturers. (Note: This will cause considerable anguish to US-based polysilicon manufacturers or manufacturers with plans to manufacture polysilicon in the US.)

Implications For First Solar

Being uniquely positioned as the only PV module manufacturer with large-scale operations, First Solar management, until recently, was concerned about the definition of "domestic content". The Treasury notification alleviates management concerns from the recent earnings call and paves the way for further expansion of First Solar's US capacity (management stated that it was holding back the decision awaiting clarity on the subject). In that sense, the news is a positive for First Solar as it forebodes additional subsidized capacity (with a government-issued check of roughly $0.17 per manufactured watt).

Investors may wonder how this definition can benefit First Solar. For example, the lax domestic content requirements can be used by project developers, who are currently First Solar's customers, in a couple of different ways:

1. A developer could use ~60% of the modules from First Solar US production and use the remaining ~40% of the modules from a secondary vendor - say a Chinese manufacturer who offers lower per-watt pricing than First Solar.
2. A developer could use ~60% of the modules from First Solar US production and use the remaining ~40% of the modules from First Solar Vietnam or Malaysia facilities.

The first option is of no benefit to First Solar (unless it can resell those modules at a higher price). The second option may drive incremental sales, but the benefit to First Solar would be small. Neither of these options should have caused a 26% runup in the stock.

But appearances can be deceptive. In addition to new manufacturing capacity, which will be a subsidy boondoggle, the Treasury guidance can benefit First Solar in a few different ways:

1. The economic power behind this guidance is phenomenal. For example, 600MW of First Solar US production can drive $100M of tax credits on a 1GW project (where the remaining 400MW are from First Solar Vietnam or other facilities). A $100M tax credit on 600MW is close to $0.17 per watt! This is as much benefit as the manufacturing subsidies! If the Company develops all of its projects in the US, the Company could nearly double its profits from US production with this tax credit alone! Of course, that will not happen as the Company will not want to alienate its customers. However, the Company could take a meaningful part of its production and use it for its own projects. The most powerful way to exploit the tax credit would be for First Solar to restart the project business the company exited in recent years. It is likely that First Solar will start taking on small projects and expand from there.
2. First Solar has mentioned in past earnings calls that the Company can benefit from an ASP modifier once the domestic content guidance becomes available. Just about the only way to interpret this is that the project developer and First Solar have agreed to split the domestic content upside in some predefined way based on the government guidance language. While Beyond The Hype has no estimate for the size of this benefit, there is likely a meaningful short-term benefit from the Treasury guidance.
3. Developers who were hoping for even more lax guidance now have few options. In many scenarios, the answer may be First Solar or nothing. This, of course, is likely to drive strong long-term demand for First Solar. Investors can expect to see a big uptick in bookings going forward. First Solar is likely closing business as we discuss the topic. Bookings are likely to spike from the current quarter.

Wrap-Up

As with a lot of policy-driven matters, the upside to First Solar is difficult to calculate. However, the upside potential is enormous. The First Solar story is not yet played out despite the 100%+ runup in the last three quarters since last year's Beyond The Hype note , and we are likely to see more good news in the next several quarters. Despite concerns about valuation, the stock is poised to continue to move up over the next 12 months.

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