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Wednesday, November 13, 2019 9:01pm

Lack Of Transparency Burns First Solar Investors Again – First Solar, Inc. (NASDAQ:FSLR)

Despite horrible headlines citing that First Solar (FSLR) missed Wall Street revenue and EPS estimates by 74% and 45% respectively, its stock only dropped by 5.8% by the end of the trading day after its earnings release. The main reason for the huge miss was a delay in recognizing high dollar value solar project sales which were pushed back into the fourth quarter. First Solar also on the margin upgraded full year guidance very slightly which reaffirmed the miss was purely due to a delayed revenue recognition issue. Although First Solar has been extremely opaque regarding their financial operations, indications from their third quarter earnings still indicate their Series 6 cost metrics remaining on target and thus well positions the company for the following fully booked year.

Lack Of Transparency

One of the main points mentioned in my last First Solar article was the lack of transparency regarding the company’s business units. As a result, we only have rough percentages and sometimes percentages of percentages of financial metrics usable to gauge the company’s earnings power. The few details the company does offer becomes almost useless as important corresponding metrics are obscured.

For example, First Solar does give a precise quarterly production number but since this does not correlate to their shipments, it is useless in determining average selling prices [ASP] for their solar modules. Some may argue management does offer information in their quarterly earnings presentations where shipments can be derived, but even this is rendered useless because actual recognized shipments do not match physical quarterly shipments. The general public is only given vague percentages that have to be pieced together through more than a single quarter’s data to get a general idea of what recognized shipments were during the quarter.

In addition, the lumpy nature of the company’s systems segment make it difficult to estimate results for any quarter. Utility scale solar project are often very large and valued in the hundreds of millions of dollars. Any delay in revenue recognition of solar system sales could easily cause quarterly estimate to miss by a wide margin. The company’s very spotty guidance relative to Wall Street expectations in the past two years offers some perspective as First Solar has missed revenue estimates seven times and EPS estimates five times out of the past eight quarters.

Although longer term investors should focus on annual results which were marginally upgraded for fiscal 2019, stock volatility created by management’s lack of transparency should not be completely dismissed. It is one story for the ordinary investor not to be able to accurately estimate the company’s quarterly results but something is not right when revenues miss analysts’ average estimates by 45%. With 14 firms covering First Solar, no one was even close which suggests something is wrong with the company’s guidance approach.

Based on the midpoint of current guidance, fourth quarter revenues could make up 54% of annual revenues. Most analysts expected this percentage for the second half, not solely in the last quarter of the year. If there was any chance revenue recognition could result push sales to the fourth quarter, management should have guided conservatively to reflect even remote possibilities. First Solar is not the only solar company that has a systems business and similarly structured peers have not missed as bad and as often.

Q1-Q3 2019 FY 2019 Midpoint Guidance Q4 EST.
Revenues $1663.7 $3600 $1936.3
Gross Profit $215.7 $702 $486.3
Gross Margin 12.97% 19.50% 25.11%

(Data compiled from First Solar’s Q3 earnings release. FY 2019 guidance uses midpoint figures. All dollar values in millions of USD.)

At least after some rightful grilling by analysts in their third quarter earnings conference call, management gave further insight on the state of certain project sales. We now know that due to ‘weather’ as much as $0.50 in EPS already guided for fiscal 2019 could be pushed into 2020. More earnings surprises could be in store for the company’s fourth quarter release.

There is news that some investors could classify as good news at least in terms of transparency. Last month First Solar announced a transition from internal development and ownership of solar projects to just a model based solely on consulting. By allowing third-party partners to take ownership of project development and ownership, the company would not only deleverage its balance sheet but also remove the choppiness in its reported results.

Although project consultation would result in lower revenues, it would provide a more steady risk free revenue source. As evident with the company’s negative 5.9% systems gross margin in the third quarter, the systems business is far from risk free. The capital freed from this business segment could be focused on module sales that could potentially generate over 30% gross margin.

Series 6 Modules Remain Key

As I mentioned in a prior article, First Solar’s Series 6 modules will be key to the company’s profitability. Ever since the collapse in polysilicon pricing a decade ago, silicon based solar modules enjoyed a manufacturing cost advantage and as a result captured over 95% of global market share in 2018. First Solar was still able to maintain positive margins but only in select markets it dominated such as the US market. To compensate for the manufacturing cost disadvantage, the company relied on its systems segment to consume a portion of its production.

Last month’s news of the divesting of its systems business to third parties should be the first indication manufacturing cost levels for its most modern Series 6 modules will be competitive enough to stand on its own. The massive third quarter earnings miss aside, operating metrics provided by the company continued to infer manufacturing cost reductions for Series 6 dropped further in the third quarter. Module segment gross margin continued to rise from -12.6% in Q1 to 5% in Q2, and finally to 18.5% in Q3(excluding special item gain). Since the company’s other module product is its legacy Series 4 which has fixed costs, margin improvements were mostly the result in Series 6 manufacturing cost reductions.

As noted above, management offers very little information regarding their operations so it is impossible to make an accurate estimation for any of the company’s operating metrics. Any estimates I provide come with a large degree of error perhaps as much as 10%, but even with this wide uncertainty gap we can still arrive at estimates that could validate the company’s long term prospects.

Average Selling Prices

The first metric we need to estimate are the company’s ASPs for their solar modules. To get this figure, we need to estimate quarterly shipments since the only known data point are module segment revenues. What management said in their Q3 earnings conference call was slightly more than 800 MW of the approximately 1600 MW shipped, less about 100 MW consumed by their systems segment, were recognized as revenue. In addition, about a third of the approximately 1300 MW shipped in the previous quarter were recognized as revenue in the third quarter.

As one can see, there are at least five variables that could have degrees of error maybe as high as 5%. Is ‘a third’ 33% or 31% or 35%? Is ‘slightly more’ than 800 MW mean 810 MW or 825 MW? However if we assume their approximations are no greater than 1% off, we can arrive at third quarter ASPs around $0.34/watt. Taking into First Solar’s market(competitor pricing subject to tariffs/duties, First Solar’s brand premium, First Solar’s contracted pricing delta, etc) into account and applying the realistic degree of error to this estimate, I believe First Solar’s quarterly blended ASPs were around $0.35-0.37/watt.

Production Costs

In order to estimate Series 6’s manufacturing costs during the third quarter, additional assumptions have to be made. The first is the assumption the ratio of shipments between Series 4 and Series 6 were roughly inline with production ratios. Based on the company’s third quarter key financial data figures, 3995 MW were produced through the end of the third quarter. Since Series 4 has been in production longer and did not require ramp time, it is likely Series 4 production ran at full capacity or about 1500 MW. Thus production cost estimates assume Series 4 shipments were about 37.5% of total shipments.

Secondly we need to back out Series 4 production costs. Management has made indications of production costs falling slightly below $0.40/watt in the past but did not give clear indications whether this milestone was the fleet average or the best production line. In addition Series 4 module efficiencies stalled out around 17% so it is unlikely average cash production costs improved much if at all. I mention cash production costs because taking into account the time Series 4 has been in production and a number of impairment charges First Solar has made in the past several years, most of Series 4 depreciation costs may be already out of GAAP costs. With depreciation factored out, I estimate Series 4 production costs to be around $0.33-0.34/watt.

As I mentioned in my previous First Solar articles, it is unlikely First Solar makes much in terms of its Series 4 sales and it is possible the company simply kept these legacy lines going to keep production steady as Series 6 ramped in capacity. However since we don’t know the ASPs for each individual product, we have to use reason to assume Series 4 ASPs should be below the blended rate while newer Series 6 ASPs slightly higher than the blended rate. As a newer product with higher average efficiencies and a larger module footprint, Series 6 modules would be cheaper to install and thus higher prices could be compensated by lower installation costs.

With these factors and assumptions taken into consideration and combined with the known quarterly gross profit for the company’s module segment, I estimate Series 6 production costs dropped to around $0.29/watt in the third quarter. This represents around a 10% quarterly decline from the second quarter and inline with the company’s original cost reduction roadmap.

While this figure may appear high relative to the company’s implied $0.23/watt year end target, First Solar is actually not far off the target it set out a couple years ago. Although the company stated 3800 MW were shipped in the first three quarters, less than a half were actually recognized as revenue. Potentially as much as 45% of the company’s module shipments could get recognized in the final quarter. Using first in first out inventory accounting, the production costs in the final quarter should see a further incremental drop due to higher utilization for Series 6 produced later in the year.

First Solar could end 2019 with Series 6 production costs around $0.25/watt based on the assumptions above and the implied Q4 metrics using the company’s guidance. This appears to be somewhat inline with management comments during its Q3 earnings conference call as they seemed to walk back year end targets slightly citing their ‘best production line’ is on track to reach costs targets. Removing ramp costs, normalized Series 6 production costs would be around the $0.23/watt range and should positively position First Solar moving forward especially after management indicated production was sold out through early 2021.

Final Thoughts

As much as some investors may dislike First Solar’s transparency and reporting history especially after the third quarter’s massive miss, the company is actually in its best competitive positioning since the collapse of polysilicon prices a decade ago. Obviously all the estimates provided above are based on a number of loose assumptions and it will be critical for First Solar to deliver fourth quarter numbers that confirm these estimates.

Whether normalized Series 6 production costs are $0.22/watt or as high as $0.25/watt at the start of 2020, First Solar will still be able to produce a very healthy gross profit next year. Assuming the company sells out its 5500 MW plus of Series 6 production next year, $0.10/watt gross profit would translate to $550 million in gross profit for just a single segment of the company’s revenues. It is even possible per watt gross profit could be higher in the $0.12-0.14/watt range which would result in higher gross profits than the company’s combined consolidated annual results this year.

While revenues would likely be lower due to the loss of project sales in its systems segment, First Solar would still be able to generate incremental gross profit through its project consulting business at a reduced operating cost. Next year’s revenues would also still likely include solar plants that have yet to be sold and recognized as revenue.

Lastly with its final Series 6 plant ahead of schedule with full utilization projected by the end of the first quarter 2020, it is possible the company might convert at least one of its two Malaysian Series 4 plants to Series 6. Additional Series 6 production would be incrementally positive over Series 4 sales that are likely only marginally profitable for the company. The company’s exiting of internal project development and sales in my opinion makes it more likely its remaining Series 4 lines would get converted sooner since liquidity would be freed up from the capital intensive project development business.

Current Wall Street estimates for 2020 are for $3.68 in annual EPS. In general that estimate definitely appears achievable but given First Solar’s lack of transparency and the importance of fourth quarter results which reflect the company’s heavily back end loaded year, it would be too soon to commit to an annual estimate figure for next year. At this potential EPS level, First Solar would be trading at approximately 15x forward earnings. While not cheap relative to historical manufacturing valuations, it is relatively cheaper than the overall market averages.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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