Utilities a boon to First Solar, but is it enough?

LOS ANGELES, CALIFORNIA - Thin-film solar companies are poised to capture a big share of the U.S. power market as utilities seek renewable energy at the lowest possible cost, but doubts are being raised about whether that is enough to support First Solar Inc's sky-high valuation.

The biggest maker of thin-film products, First Solar has been a Wall Street darling since it went public in 2006 because its cadmium telluride solar cells are far less costly to produce per watt than the silicon-based cells that dominate the market.

Electricity produced from the sun is pricier than that from dirty sources like coal-fired plants, so cost is paramount when choosing among solar suppliers. For that reason, thin-film suppliers are expected to pick up big contracts in states such as California, which is requiring that 20 percent of the state's electricity come from green sources by 2010.

"Thin film is really the leading edge for satisfying demand from the utility market," said Ted Sullivan, senior analyst at market research firm Lux Research.

"Utilities are sophisticated buyers. All they care about is the lowest cost."

Thin film's cost advantage over cells made from silicon, along with clean-energy requirements from a growing number of states, have underpinned investor enthusiasm for First Solar.

At the same time, thin-film panels produce less energy than traditional photovoltaic technology. That makes them better for big installations in the desert, where there is ample space, and less attractive in small areas like residential rooftops.

"The whole market can see a lot of really impressive growth in the long run, but that's not to say thin film will displace everything else," said Raymond James analyst Pavel Molchanov, who has a "market perform" rating on First Solar. "It's a low-cost product, but it's lower performance."

First Solar shares were 1.6 percent higher on August 12 at $252. They have been largely immune to a sharp sell-off in solar stocks, down just 6 percent this year. That compares with declines of more than 40 percent for leading silicon-based cell makers SunPower Corp. and Q-Cells AG.

First Solar trades at about 36 times analysts' average 2009 earnings estimate, compared with multiples of 21 and 19 for SunPower and Q-Cells, respectively.

"There are high hopes of them launching a business model with electric utilities," said Karina Funk, senior equity analyst with Boston-based Winslow Green Mutual Funds, which owns First Solar shares.

Whether those high hopes will translate into the hefty returns many investors expect is a major question. Last month, First Solar announced two contracts with California utilities Sempra Energy and Edison International unit Southern California Edison, and Funk said some investors had been hoping for further news on the company's utility business strategy during its earnings conference call last month.

First Solar's blow-out quarterly earnings on July 30 prompted many analysts to upgrade the already-richly valued stock to "buy" and assign 12-month price targets of between $350 and $450. At the time, the stock traded at $285.

Friedman Billings Ramsey analyst Mehdi Hosseini, who has an "underperform" rating on First Solar, warned that it was still too soon to evaluate opportunities in the U.S. utility market.

"The utility market is a market that could be the gold mine for the solar industry, but we don't know how the subsidies are going to play out," Hosseini said. "There are a number of key questions that nobody has an answer for."

The biggest question, Hosseini said, is whether key U.S. solar energy subsidies that expire at the end of this year will be extended, and if so, how long for. Also, in their current form, the utilities themselves are not able to take advantage of the tax breaks. Instead, they must work with third parties who build the solar power plants and then sell them the power.

"If the subsidy is given to utilities, then all they need is First Solar to come in and sell modules or systems," Hosseini said. "In that process, utilities could potentially put more pressure on First Solar to lower prices."

In addition, investors are mindful that dozens of companies - from established solar players to venture-backed start-ups - are hard at work trying to replicate First Solar's success.

Applied Materials Inc., which was due to report earnings on Tuesday, is selling thin-film production lines for customers including Suntech Power Holdings Co Ltd., while big names like Sharp Corp. and General Electric Co. are also cultivating thin-film businesses. Energy Conversion Devices Inc. is the only other large public thin-film company - and its technology, based on amorphous silicon, is different from First Solar's.

"It does have a scarcity premium in the valuation," Molchanov said of First Solar. "And yes, it does deserve to trade at a higher multiple, but obviously it's debatable whether those types of valuations are sustainable forever."


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