Will First Solar Be A Beneficiary Of The AI Boom?

First Solar (NASDAQ:FSLR) stock has performed well this year, rising by over 50% since early 2024, as it benefits from regulatory tailwinds, easing supply chain issues and strong demand for renewable energy.  The company’s recent performance has also been better than expected. While revenues rose by 45% year-over-year to $794 million, earnings came in ahead of estimates at $2.20 per share. Besides this, investors are also betting that the company could also emerge as a beneficiary of the booming artificial intelligence industry.

There is optimism that higher demand for artificial intelligence applications will drive up demand for solar power as big tech companies build out massive data centers powered by graphics processing units.  AI-based queries are very computationally intensive, calling for higher electricity usage. Per some estimates, a typical AI query uses about 10 times more electricity than a regular search engine. Solar power could be an ideal form of energy to bridge this energy gap, given its low costs and low carbon intensity. Although there are limitations to renewables, given the intermittent nature of power output based on weather conditions and the time of day, big tech players typically use renewable power purchase agreements to offset their fossil fuel consumption. AI-related power demand could surge as AI models get more sophisticated, moving from processing not just text, but also generating images and videos. First Solar should be a big beneficiary of this trend for a couple of reasons. Firstly, the company’s cadmium telluride panels are favored for large utility-scale solar installations compared to many other players who focus on rooftop installations. Moreover, the company has a solid presence in the United States, where much of the AI-related action remains. First Solar derived over 95% of its net sales last year from the U.S. alone.

The current regulatory environment is also very favorable for U.S.-based solar manufacturers such as First Solar.  The Biden Administration recently increased tariffs on solar cells imported from China from 25% to 50%, in a move that will raise the competitiveness of the U.S.-based manufacturers. Separately, First Solar is also benefiting from the Section 45X tax credit under the U.S. Inflation Reduction Act, given that it has been doing an increasing mix of its manufacturing in the U.S. For perspective, toward the end of December 2023, the company announced that it had signed agreements for the sale of up to $700 million in 2023 tax credits it earned under the act. The company is likely to realize $1.0 billion to $1.05 billion of Section 45X tax credits this year as well, adding directly to its operating profits.

First Solar’s production base has also been growing, driven by expanding capacity in Ohio. Total nameplate manufacturing capacity stood at 16.6 GW in 2023 and the company expects capacity to grow to over 25 GW by 2026, led by expansion of its Series 7 panel manufacturing in the U.S. in locations including Alabama, Louisiana, and Ohio. First Solar also has a healthy backlog of bookings that has grown to over 78 GW as of the end of March 2024, up from 61.4 GW at the end of 2022. This gives the company solid revenue and gross margin visibility, with prices more or less locked in for 95% of the backlog.

FSLR stock has seen extremely strong gains of 160% from levels of $100 in early January 2021 to around $260 now, vs. an increase of about 45% for the S&P 500 over this roughly 3-year period. However, the increase in FSLR stock has been far from consistent. Returns for the stock were -12% in 2021, 72% in 2022, and 15% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that FSLR underperformed the S&P in 2021 and 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Information Technology sector including MSFT, AAPL, and AVGO, and even for the megacap stars GOOG, TSLA, and AMZN.

In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could FSLR face a similar situation as it did in 2021 and 2023 and underperform the S&P over the next 12 months – or will it see a strong jump?

Overall, we think that there are multiple long-term positives for the solar sector at large and First Solar in particular. Things are getting better on the macro front. Inflation has cooled off considerably. The Federal Reserve is considering possibly reducing interest rates in 2024. This should bode well for renewable energy stocks, by making financing of large-scale projects more affordable. First Solar is emerging as one of the big beneficiaries of the U.S. efforts to encourage domestic renewables production given its vertically integrated manufacturing. That said, there are risks as well. A meaningful part of First Solar’s strong financial performance can be attributed to the Inflation Reduction Act and the upcoming U.S. Presidential and congressional elections due later this year could prove a risk for the company.  Inflation Reduction Act-related tax credits could be modified if Republicans, who typically favor a market-based approach over subsidies for renewables – come to power. That said we remain neutral on First Solar stock, with a $235 price estimate, which is slightly below the current market price. See our analysis of First Solar Valuation: Expensive or Cheap for more details.

[1] Returns as of 6/25/2024
[2] Cumulative total returns since the end of 2016

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