Investment Case First Solar
Since December 2014, the Kempen (Lux) Global Small-cap Fund is invested in First Solar, one of the leading global manufacturer of solar panels. The current overcapacity in the highly-competitive solar panel market has led to low sales prices, severely squeezing profitability in the sector. In the long term, however, we see a sunny future for First Solar.
Clean energy is the future
In June we attended a conference in London at which we talked to several companies from the wind power and solar energy sector. The main message was the confirmation that alternative energy is already in a position to compete with traditional sources of energy as a result of a sharp decrease in costs and increased efficiency. Solar energy is of course also cleaner than traditional sources of energy, which have a greater adverse effect on the environment. We expect a further decrease in costs due to efficienncy gains over the next few years and therefore believe that the market for alternative energy will continue to experience strong growth.
Unsubsidised comparable energy costs (US$/MWh)
Source: First Solar, Yearly study by Lazard of estimated costs of energy – December 2016
Industry under pressure due to overcapacity
The positive outlook for the sector is not yet visible in the equity prices of many of the companies in the alternative energy sector. Solar panel manufacturers are experiencing pressure caused by extreme competition from Chinese manufacturers in particular: these have expanded their production capacity over the past few years. At the moment, solar panels are sold almost at cost price. Recent quarterly results show that this is severely squeezing the sector’s profitability. Most manufacturers have substantial debt positions as a result of the high level of investment in capacity. The question is therefore how long these parties can survive. A petition has even been filed by nearly bankrupt company Suniva calling on the US government to impose import duties on Chinese solar cells. Import duties could result in temporarily higher retail prices, from which First Solar could also profit. However, we do not take this into account in our basic scenario.
Source: First Solar, solar energy project
First Solar differs from most of its competitors in many respects. For a start, it is a US company that takes rational decisions, while most Chinese companies expose themselves to multiple higher risks, aimed at growth and achieving market leadership. Next to that the technology that First Solar uses to make its solar cells is also different. Most of its competitors manufacture cells using silicon. First Solar uses a different material, making the technology highly scalable and potentially cheaper in the production process. First Solar is currently working on a new generation of this technology. We believe that the company will be able to manufacture its cells at the lowest costs in the industry in 2020. We recently talked to the CFO at the clean tech conference about the roadmap for cost development that the company has communicated. According to the CFO, First Solar should be able to achieve healthy margins from this latest generation over the next few years, even if competitors continue to manufacture silicon based solar panels at cost price.
Source: First Solar, production of solar panels
Robust balance sheet creates safety margin
We are aware of the risk of investing in promising new technologies. Even though First Solar has a strong track record in achieving technological objectives, the pace in technology is fast. There is always a risk of the First Solar technology not being competitive. For example, as a result of technological innovation among competitors. It is therefore always important to examine both the potential and the risk. We believe that the downside technology risk at First Solar is protected by a very robust balance sheet. First Solar holds a large net cash position compared to its peers, that are weighed down by debt and can barely keep their heads above water. Moreover, First Solar has interests in projects that have already been implemented and a large number of projects under construction on the balance sheet, which are highly likely to be sold at a higher price than their book value. This cash position and the value of the projects together represent a large portion of the current stock value, what provides downside protection. This in turn enables First Solar to invest in new technologies, even when the sector is struggling, and to maintain a strong position amongst its competitors.
A sunny future?
Given the industry’s risk profile and the fast technology developments in the solar panels markets/alternatives industry, the stock price of First Solar equities will probably remain volatile over the next few years. We believe that long-term investors will be adequately compensated for this volatility. In our view, First Solar is excellently positioned to profit from the expected growth in solar energy.
Date: 1 August 2017
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This document is prepared by the fund managers of Kempen (Lux) Global Small-cap Fund (‘the Fund’), managed by Kempen Capital Management N.V. (‘KCM’). The Fund currently holds shares in the subject company. The views expressed in this document may be subject to change at any given time, without prior notice. KCM has no obligation to update the contents of this document. As asset manager KCM may have investments, generally for the benefit of third parties, in financial instruments mentioned in this document and it may at any time decide to execute buy or sell transactions in these financial instruments. The information in this document is solely for your information. This document should not be considered to constitute an investment recommendation and it is not intended as an offer or a solicitation to buy or sell any financial instrument mentioned in this document. This document is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The views expressed herein are our current views as of the date appearing on this document. This document has been produced independently of the company and the views contained herein are entirely those of KCM.