First Solar's 2016 Guidance Belies Its Recent Strength

First Solar ( FSLR ), the largest U.S. solar manufacturer, provided relatively conservative guidance for 2016, projecting modest revenue growth (13% at the midpoint), flattish shipments (4% growth) and contracting gross margins (7.5% lower). The outlook is somewhat lackluster,given that 2016 is expected to be a strong year for the U.S. solar market amid a rush by project developers to avail the Investment Tax Credit which is slated to expire at the end of the year. In this note, we provide some of the key takeaways from the guidance and what it could mean for First Solar going forward.

Our $63 price estimate for First Solar represents a 15% premium over the current market price. We are currently updating our model to account for the 2016 guidance.

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Guidance Is Conservative, But There's Flexibility To Scale Up

First Solar is projecting module shipments of 2.9 GW to 3 GW - 2.4 GW for its own systems projects - for the next year, translating into growth of under 5% at the mid-point . This is surprising, given that First Solar is the largest U.S. solar manufacturer and the Solar Energy Industries Association is forecasting 25-50% solar market growth in the U.S. for 2016. The company also noted that its 2016 module production would only rise by 20% year-over-year to 3 GW . We expected the growth rate to be higher, given the company's conversion efficiency and line rate improvements, increased utilization as well as the addition of two production lines that came online in 2015.

That said, First Solar has a track record of being conservative with guidance, and there is a possibility that it will beat expectations or raise guidance going into next year as it has done over the last few years. For instance, the company noted that it holds some idle equipment and it retains the ability to expand its production if required at short notice. This would allow First Solar some room to evaluate capacity needs as it moves through 2016. Separately, the company could be planning for a situation where a"commence construction" modification is incorporated into the ITC by Congress, which would allow developers to move some of their 2016 project completions into 2017, reducing 2016 demand.

Gross Margins To Decline On Project Mix, Revenue Recognition

First Solar's Gross margins are projected to decline by about 750 basis points next year. There are two broad reasons for this. Firstly, the net sales and gross margin guidance numbers do not include the upcoming sale of the company's minority interest in the Stateline PV project - which is accounted for as an equity method investment. The profit on the sale will be recognized under equity and earnings and not under revenues and gross margins. First Solar notes that margins would have been 200 basis points higher if the transaction were treated as a typical sale. The company also expects a change in mix of systems projects, with an increase in third-party EPC contracts - which have thinner margins - and a lower mix of more lucrative projects where it is the developer. That said, the company might be underestimating the impact of improvements in panel efficiency and manufacturing technology, which should allow for significant cost reductions at the factory level.

Panel Efficiency Gains Will Continue To Outpace Industry

First Solar expects panel efficiencies to average 16.2% in 2016, up from about 15.5% this year, which should allow the company to move ahead of many polycrystalline panels in terms of performance. It will also reduce manufacturing costs and improve manufacturing capacity, as each module will deliver a higher-rated capacity as efficiency improves (these gains are factored into the company's production guidance). Lead line efficiencies are expected to rise to 17+% by the end of 2016. The company typically looks to achieve a fleet average efficiency that equals the exit lead line efficiency of the previous year.

Balance Sheet Position Will Strengthen

Capital expenditures are expected to almost double to between $300 million and $400 million in 2016, as the company invests in equipment and tools for the next scheduled advancements in its technology roadmap. Net cash at the end of next year is expected to range from between $2 billion and $2.3 billion, up by 60% from this year's target. This would imply net excess cash per share of over $20, accounting for close to 35% of the company's stock price. Moreover, with the upper end of EPS guidance coming in at $4.50, that would imply a P/E of just 7.8x adjusted for cash, which is well below most other companies in the solar industry.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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