Solar energy is expected to be the fastest growing energy source worldwide. Solar energy's share in global electricity generation is expected to rise from a mere 3% right now to more than 20% by 2050. That's surely good news for solar companies, including solar panel manufacturers. However, that does not guarantee rosy days for leading U.S. solar panel supplier First Solar (FSLR -0.99%). On the contrary, the company faces some key challenges. Let's see what this may mean for First Solar stock.
Competition
First Solar grew its quarterly revenue at an average rate of around 13% over the past ten years. That looks impressive. However, it pales compared to JinkoSolar's (JKS -5.51%) average growth of around 35% over the same timeframe. JinkoSolar also beat Canadian Solar's (CSIQ -4.16%) 17% average revenue growth during this period.
CSIQ Revenue (Quarterly) data by YCharts
On a positive note, First Solar generated higher average gross margins than both its competitors during this ten-year period. First Solar can possibly beat low-cost competition by better products that generate higher margins.
CSIQ Gross Profit Margin (Quarterly) data by YCharts
However, things look different when you look at recent margin numbers. First Solar's average gross margins over the last three years were 17.6% compared to 10-year average of 22.4%. This fall reflects the kind of margin pressure that First Solar faces and will continue to face in future as well.
CSIQ Gross Profit Margin (Quarterly) data by YCharts
The rise in First Solar's gross margin in the latest quarter as seen in the above graph is due partly to certain project sales in Japan and India, earnings that fluctuate a lot and are not recurring. Moreover, the company is exploring options, including sale, for its U.S. project development business.
A more focused approach
First Solar's decision to explore options for its project development business is based on cost-return analysis in a competitive segment. This is part of a series of steps that the company has been taking to become a more focused solar panel manufacturer. First Solar exited from its engineering, procurement, and construction business (EPC) business in 2019. The company now uses third-party EPC services for its customers. In August 2020, First Solar agreed to sell its operations and maintenance business to NovaSource. The idea is to focus only on highest margin offerings. While this limits growth avenues for the company, it’s the right approach to improve returns.
Image source: Getty Images.
Meanwhile, First Solar hopes to expand its module production capacity to around 8 GW (gigawatts) by the end of 2021. That's an addition of around 2.5 GW from its expected 2020 shipments of 5.5 GW to 5.7 GW.
Outlook
Favorable policy environment should benefit solar companies, including First Solar. The company has taken, and continues to take, several steps to become more cost competitive. It has opened production facilities in Vietnam and Malaysia and is exiting low margin businesses. If it can continue to manage costs, the potential market is vast. However, margin pressure remains huge in this extremely competitive market, which limits potential for bottom-line growth.
CSIQ PE Ratio data by YCharts
First Solar is trading at a PE ratio of more than 50. That's not only much higher than market ratio, but also higher than its peers. Solar stocks' higher earnings growth likely account for their higher PE ratios than broader market.
Notably, First Solar has historically traded at a premium compared to its non-U.S. peers. However, the stock has been underperforming its peers, likely reflecting a more limited earnings growth ability than earlier thought. Solar energy's growth potential provides a nice tailwind to solar stocks. While First Solar too is poised to grow, the stock may continue to underperform its peers. In comparison, I find Canadian Solar better based on its valuation and growth prospects.
