Thursday, March 31, 2011

Update of Portfolio: First Solar (FSLR)



Today, I will be talking about the third stock in my portfolio: First Solar (Ticker: FSLR).  First Solar is a company that makes photovoltaic (PV) panels and is also involved with large scale PV project developments.

When a typical Joe hears the words, solar energy, he is likely to think of inefficient and expensive solar panels lined up row after row in a remote desert somewhere.  There is some truth to that, but the technology is starting to gain wide acceptance, especially after the tragic Japanese Tsunami that crippled a number of nuclear plants in Japan.

I like First Solar for a variety of reasons.  It is a "best of breed" stock in many aspects.

  1. Its capacity will be around 1.4 GW in 2011, which will likely be about the 2nd largest in the world.
  2. It has the lowest cost per watt, at about $0.77/W at the end of 2011.  The closest competitor, Yingli (Ticker: YGE), is at about $1.11/W.
  3. It is the only successful thin-film solar manufacturer.
  4. As a result of its low cost structure, it has one of the highest operating margins in the high 20s, which is more than the gross margin of many other solar companies!


Figure 1: Rule #1 Analysis of First Solar (FSLR)

The past 12 months have been good for renewable energy.  First, there was the BP Oil Spill.  Then, the Japanese Tsunami and the subsequent nuclear plant incident.  These are tragic events, but sometimes, humanity requires a shock to our system to really wake up from our dream.  China is now putting on hold new nuclear plant developments.  Tens of thousands of German citizens protested against the use of nuclear energy in the wake of the Japanese Tsunami.  2010/11 will mark the turning point in human history with respect to energy use.

It is true that solar energy will likely not replace the nuclear plants in Japan.  However, as the world awakens to the renewable energy revolution, more and more emphasis will be put on solar (and wind and geothermal). I want to make sure that I ride that wave once it hits (sorry, no pun intended).

There are some skeptics and their arguments are logical, but I will show you why First Solar can withstand even the worst-case scenario.  One of the most cited argument against solar places concerns over an oversupply of solar panels, coupled with decreased government subsidies.  Many solar companies are ramping up their production.  As the argument goes, there will simply be too many panels around and not enough demand.  As a result, the prices of panels will drop.  Companies will lose money and as a result, you will lose money if you're invested in solar.  Decreased government subsidies just aggravate the problem.

Yes, I agree with these skeptics that there will be fallout.  Evergreen Solar (Ticker: ESLR) will be one of the first to go.  The companies without meaningful profit and a lot of debt will all be in trouble.  But I'm not worried, because I've got the best of breed.  First Solar is currently making money hands over fists.  Gross margins are super high at around 50%.  Trina Solar's cost, which is its closest competitor, is about 44% more expensive than First Solar's.  If the average selling prices (ASP) drop significantly, if anyone will continue to make  money, it will be First Solar.  Regardless of how much supply there is in the market, the lowest cost manufacturer will always make money.  Ok, well, not always...but it does not make logical sense that even the lowest cost manufacturer needs to sell at a lost, as long as there is demand for solar panels.

First Solar investors should actually want ASPs to drop significantly.  What will happen is that the high cost manufacturers will start to sell at a lost.  Eventually, they run out of funds and are either bought out or have to close shop.  The supply of panels will drop as a result, leaving only the stronger players.  There will be consolidation in the solar market, but after this consolidation, First Solar will emerge stronger.

Rule #1?
You bet that First Solar is a Rule #1 stock!  Growth has been steady and phenomenal and I believe it will continue to be phenomenal.  Sticker Price/Intrinsic value is at $303, and so the stock is still undervalued.  My average price is $131.60 and the stock closed at around $160 today.  If the stock drops below $150, I may start buying again, but at the current price, I'm in a holding pattern.

This stock is also fairly volatile.  So, if it hits $170-180 in the short term, I may unload some shares and wait for a pullback to buy again.

Conclusion
Should you buy?  It all depends on your appetite for volatility (notice I didn't say "risk").  I believe the stock has relatively low risk for several reasons: its past performance, its current state (which is excellent), and the current price is not too high.  However, the amplitude of price fluctuations is large.  So, if you can stomach seeing your holding drop 20% in a couple of weeks, then this stock may just be for you!