Throughout the 1990s tech boom, Dell (Nasdaq: DELL) made life miserable for any other firm trying to sell computers. Its lean operations enabled it to generate solid profits even as price wars kept most rivals' bottom lines in the red. First Solar (Nasdaq: FSLR) has taken a page from Dell's playbook, establishing a cost structure and pricing model that ensure profits for itself and pure misery for its rivals.
There is a key distinction between Dell and First Solar, however: Dell held no inherent technical advantage and was ultimately unable to distinguish itself as computers became commodities. First Solar's intellectual property, on the other hand, is a key differentiator. The company developed a novel and successful way to mass produce solar cells using cadmium and tellurium in an industrial process that allowed it to use very small amounts of these metals. This reduced its costs to about half of its competitors.
First Solar is now the global leader in the production of thin-film solar, which captures less of the sun’s energy than traditional silicon-based solar panels but can not only be made far more cheaply but also can be deployed in a wider variety of applications. The company’s aggressive pricing led to a sharp rise in sales in recent years, even as demand for other solar players’ panels flattened out.
The solar industry is set to suffer the ill effects of a spending boom that started two years ago, when oil prices led investors to pump money into additional solar-panel production capacity. In recent quarters, global supply has been ramping up, creating a glut that likely will hammer prices later this year. This helps explain why earnings estimates for First Solar -- and all of its peers -- have been falling in recent months. Stock prices in the group have followed suit.
When the dust settles, investors will seek the companies with the most compelling technological platforms and the strongest balance sheets. First Solar, already the low-price leader, has consistently been able to lower its manufacturing costs, which are set to fall even further in coming years. In 2007, the company was able to build modules for roughly $1.40 per watt of power. That figure breached the $1 mark late in 2008, and could approach $0.75 sometime later this year. The company now spends roughly $100 million per year on research and development.
Rivals utilizing the traditional silicon-based approach have also lowered production costs, and the gap between the two technologies has remained relatively constant. Realizing that rivals might willingly lose money on contracts in order to preserve market share, First Solar has used its robust balance sheet to buy up demand. It's acquired development rights to build major power plant projects that ensure a steady need for the company’s gear. That shift has forced investors to grasp a changing business model – one with higher sales but lower profit margins. The company issued sales guidance that was well above consensus forecasts, though profit forecasts were only in line with existing expectations.
As you can imagine, that’s a lot for investors to digest, which explains why they have been walking away from the stock. Its shares have fallen nearly -50% since last June. The long-term prognosis is for a continued upturn in solar-cell demand that will catch up to the industry supply glut, probably in 2011. That should help prices stabilize or even rebound. Couple that with the fact that First Solar is expected to complete the production of new facilities later this year, and First Solar may see sales and profits rise at a +20% to +30% clip in 2011.
First Solar shares have rarely traded this cheap -- currently for about 14 times forecasted earnings. That’s roughly on par with the broader market, and discounts the value of the company’s pristine balance sheet (roughly $600 million in net cash), leading-edge technology, and dominant market share of roughly 20%. Although it will take some time before investors look out to 2011 and beyond, when they do, they will see an industry – and a stock – that is poised to make a continuing dent in the global energy picture.