Four takeaways from First Solar’s short-term trimmings, long-term sights

First Solar’s lowering its 2011 and 2012 outlooks shows that market forces rule all, but the company’s roadmap to recovery draw a few interesting lines in the sand for competitors — if it can make some aggressive numbers.

December 15, 2011 – First Solar has unveiled some sweeping changes in its business outlook for 2011 and 2012 (including some reorg and personnel shifts), as it turns its back on “structurally imbalanced” subsidy-driven markets and tries to find more sustainable markets hungry for solar PV energy generation — and hopefully some defensible marketshare turf.

Nobody’s safe from market woes

Here’s a summary of FSLR’s new 2011 numbers vs. old — mainly dented by projects’ weather/financing delays (and not including impairment and other charges, primarily equipment-related, that could take out another $0.75 in EPS plus $0.10 in severance):

— Revenues: $2.8B-$2.9B (vs. $3.0B-$3.3B)
— EPS: $5.75-$6.00 (vs. $6.50-$7.50)
— Consolidated operating income: $575-$600M (vs. $650-$760M)
— Capex: $750M-$800M (vs. $800M-$850M)

And here are FSLR’s new 2012 expectations:

— Revenues: $3.7B-$4.0B (includes $1.7B of EPC/project development), operating income: $425-$450M, EPS: $3.75-$4.25 (that’s about half of what Street analysts have been hoping for), capex: $375M-$425M
— 1.2GW of installations (DC), 80% of which is under contract. (720MW DC in modules)
— 2GW of production, plants running at ~80% utilization, no more commercial production at Mesa during 2012, and “strategically leveraging manufacturing downtime”
— Average module costs reduced to $0.72/W; this includes $0.06-$0.07 attributed to underutilization, kicking in 1Q12 and lasting through 4Q12
— Average module efficiency 12.6% — up from 11.7% in 2011. By quarter FSLR projects an incremental increase, topping at “best-plant” 12.9% by 4Q12

Beyond the new numbers, FSLR is also merging its utility and components business groups; Jim Brown is the new president of global bizdev, while TK Kallenbach, president of the components group, is leaving as of Jan. 1 2012. And a reorg in FSLR’s finance and accounting groups will mean the departure of chief accounting officer James Zhu effective in May; CFO Mark Widmar will take on those additional duties.

More strategically, noncore initiatives such as rooftop projects and offgrid applications, “will be on the back burner,” chairman/interim CEO Michael Ahearn said during the company’s conference call, as the company dedicates “all resources” to reducing total installed costs to utility-scale power plants, optimizing designs and logistics and grid integration. This apparently includes the company’s skunkworks CIGS R&D operation out of Santa Clara, and reportedly the exit of ex-Solyndra tech exec Markus Beck and nearly five dozen other employees. (Dow Jones claims the decision was strictly financial and not about the tech’s performance; during the conference call Q&A Ahearn noted that if the company’s Santa Clara operation had continued at the same R&D spend, “we would’ve seen a significant increase,” but now R&D in 2012 is seen at flat.)

Bet long to win big

Long-term, FSLR is laying out a plan for the following metrics:

Revenue 5%-10% CAGR, gross margins 15%-20%, operating margins 8%-12%, free cash flow % of net income 60%-80%.

2015 targets: Module costs $0.50-$0.54/W, 14.5%-15.% efficiency, and $0.70/$0.75/W BOS costs. The higher efficiency projections obviously are a key driver of lower costs; during the call Ahearn explained that the company’s become much better at accelerated field reliability testing/predictability than just a year or two ago. Those BOS costs are a big improvement over previous projections of $0.91-$0.98 by 2014. Widmar also mentioned that c-Si cost parity/W right now is $0.52/W, and will be $0.57/W by 2015

LCOE of $100-$140/MWh, and system price (excluding owner development costs) of $1.40-$1.60. “We cannot even begin to have a serious discussion with policymakers, regulators and utilities about large-scale solar generation until we’re prepared to price it on subsidized levels at scale,” Ahearn said. Widmar clarified: “We believe an LCOE of $100 to $140 per megawatt hour will open up most markets. To achieve that requires a module and BoS system price of around $1.40 to $1.60 per watt” (plus ~$0.20/W of development costs).

Ahearn reiterated the strategic necessity of that LCOE mark of $1.40-$1.60 during the call, squarely addressing Chinese poly-Si competition: “It’s one thing to sell through existing capacity and recover your cash costs. I think it’s another thing to invest billions of dollars in new capacity knowing for a fact you could never make a profit.”

(Interestingly, in practically the next breath Ahearn explained that in these new sustainable solar-hungry markets, “the real competition, as we shift, is thermal […] we need to focus on that, the road ahead, as opposed to the rear-view mirror for these silicon guys.” Later on he said it again when asked about industry consolidation, noting that “the real competition are the thermal plants that we will be replacing or at least substituting for on a go-forward basis.”)

One thing FSLR won’t do to encourage investor confidence is buy back stock. “Taking cash which we can totally use to fund our growth and the buffer variation to buy back stock, to drive the share price, doesn’t strike us as a smart thing to do from a fundamental point of view,” Ahearn said during the call. “We’ve listened to several suggestions that we considered it and we’ve rejected that idea.”

It’s about sustainable markets, not subsidies

During the conference call, Ahearn made no bones about the industry’s precarious position: it is “structurally imbalanced,” weighed on one end with uncapped and growing production capacity, and declining installation capacity crimped by subsidy levels on the other. “In an industry without entry barriers, which we believe is now the case for [the] polysilicon PV module industry, the easy re-entry of competitors and expansion of capacity will keep downward pressure on prices and margins indefinitely,” he said. “Open, transparent and uncapped markets cannot survive politically in an oversupplied industry with no entry barriers.” Such markets are increasingly unable to keep up with the volume push from suppliers, and these markets and their programs are “shrinking” and won’t come back, he said.

[Credit Suisse’s Satya Kumar has the most succinct quip we’ve seen so far:  “We cannot begin to fathom what this means for the hundreds of thousands of tons of poly capacity that is already online, and the tens of thousands of tons of planned additional poly production through 2012.”]

What it all comes down to, according to Ahearn, is that FSLR must keep playing the “whack-a-mole” — where an oversupply supply-chain waits for the next subsidy market to pop up so they quickly descend and battle it out for a share of limited volumes — “or find another game to play. We’ve decided to move to another game.” That means getting out of subsidized markets and finding “sustainable” ones that don’t depend on subsidies, and offering utility-scale PV energy generation in geographic markets that immediately need it. More specifically that means turning away from traditionally noncore markets i.e. not “inverted-V” Western markets (Europe and also the US), and emphasizing places like China, India, Africa, and the Middle East — a point the company made during its 3Q11 quarterly results call in November. The company’s technology/cost threshold and US project pipeline will keep it profitable for now, but “we must find a way to grow dramatically, notwithstanding a challenging environment” — a 20% CAGR would mean adding 65GW over the next 10 years, he calculated. Bottom line: FSLR needs “substantially all of our new revenues from sustainable markets by the end of 2014,” Ahearn said.

Prompted by inquisitive analyst Vishal Shah from Deutsche Bank, Ahearn noted that these future sustainable markets don’t just mean India: “there are 5 or 6 geographic markets that can yield significant unsubsidized opportunities,” he said. “I believe what we will show in the 3-year plan is actually several markets that can roll up, assuming things break.” Of course there’s some uncertainties in play, from project financing to transmission issues. China, meanwhile, has “a big energy problem, a big carbon problem,” and shifting the load “means a pretty big role for solar” — and not just to support domestic manufacturers. Ahearn thinks FSLR can “elevate the discussion in China away from trade skirmishes and sort of the small conversation to the larger one: how can we bring the most advanced technology in the world to a market with one of the biggest fundamental needs for energy and help them solve the problem? […] I’m optimistic that we can make something happen in China.” Widmar also said FSLR is “seeing some other traction in markets such as Thailand.”

Find new customers… or a suitor?

Some industry watchers might have hoped for more fiscal optimism after FSLR finally sold its 550MW Topaz project earlier this month, but in reality it’s not too surprising that the company is being affected like everyone else. In fact, FSLR’s in a tough place right now with its captive customer base, says Deutsche Bank’s Vishal Shah: Many of its take-or-pay contracts are up in 2012 and are unlikely to be extended (several customers probably wouldn’t be able to honor them anyway), and any contracts outside Europe would be short-term with spot-market characteristics. He notes that with the current systems project pipeline rapidly narrowing, FSLR needs to get new projects going in just such sustainable markets, likely with its ~$1B of anticipated 2012 cash flow.

Will hitting its targets be enough to keep FSLR on top of the solar game? Even if those $0.52/W costs by 2015 pan out, “it will remain very challenging to make much money pricing at $0.60/W,” says Citi’s Tim Arcuri, assuming the c-Si pricing equation stays so punishingly low ($0.80/W, as poly-Si approaches $25/kg — though even he admits $25/kg is unsustainable). Arcuri sees two likely end-games, then: FSLR is taken private (with massive upfront capital requirements) or finds a rich parent (he suggests GE or Samsung “for technology differentiation.”) [We would note that GE-buying-XYZSolarCompany has been a favorite rumor for a long time… but GE’s Jeff Immelt in this week’s quarterly call specifically said: “There’s a lot of carnage in the solar industry right now […] I think our preference is to build organically and do it over time and stay profitable and see where it goes.”]

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