As many investors who closely follow First Solar (FSLR) may remember, I wrote an article on the company back on November 6th. At the time I wrote the article, shares of First Solar were trading at approximately $22.50 and I predicted they could easily double by the middle of 2013. They've been on the rise ever since. Given the run-up in the stock price since that time, in combination with an earnings release only one month away, I thought this may be a good time to revisit the company.
What I love most about investing is when I'm able to find a pure value play amidst an industry under pressure. The solar industry, as has been written about to exhaustion, has had a glut of over-supply. Chinese companies have flooded the market with inexpensive photovoltaic panels and the trend does not seem to be reversing. Recently, Barrons published an article wherein renewable energy analyst Gordon Johnson was interviewed and painted a very bleak picture for the world solar industry and, more importantly to me, First Solar. While I actually agree with a fair amount of the article as it relates to the historical challenges faced by the industry at large and many of the companies within it, it would appear to me that Mr. Johnson has made the same mistake many analysts and investors have made in relation to First Solar, and that is to paint it with the same brush as the industry itself through use of far too many generalizations. Let's face it, a company will, more often than not, be compared to its industry index. If an industry falls out of favor, a good company's stock can easily decline, even if the individual company's fundamentals are strong. Such is the case with First Solar. While the entire solar index has enjoyed a rebound over the past several months, for most solar companies, much of this is hype rather a rebound in sound financial performance, (or the promise thereof). It's no secret that many solar companies have balance sheets that any investor should run from, having scary debt-to-equity ratios and even negative, if not very negative, book values. It would not surprise me in the least to see no less than 2 to 4 major solar players become insolvent within the next 18 months alone. That said, First Solar is not among them.
Some of the things Mr. Johnson seems to have missed when denouncing First Solar and the industry in which it operates:
1) While he correctly points out that many countries have cut government funding for solar, there seems to be no discussion of developing markets where government subsidization and investment plans over the next ten years will far exceed the amounts expended internationally over the past ten years. Look no further than the Middle East. As can be seen on the site, not everyone agrees with Mr. Johnson's assessment with regard to industry growth or future government support. Starting on February 17, a brand new exhibition dedicated to solar energy will take place in Dubai where there was a recent announcement of a 1,000MW, $3.3B solar project, (I didn't see that mentioned in the Barron's article). Those planning the exhibition have estimated total worldwide investment in solar energy will reach between $800B and $1.2 trillion over the next decade. As if the Middle East doesn't present enough of an opportunity, India has just announced further investment in an additional 1GW of solar power, on top of previously announced projects that First Solar is already participating in. Again, all of this is in addition to the growing investment in China and continued growth in the United States. Insinuating that solar energy production has either peaked, or soon will, is beyond naive.
2) I have to admit, as a Chartered Accountant, (CPA equivalent in the US), I like looking at a company's fundamentals and thoroughly enjoy when I read what I believe to be the misguided musings of any analyst with regard to accounting policies. Mr. Johnson goes on a bit of a tangent with regard to First Solar's percentage of completion revenue recognition policy, (a widely used practice of accounting for project-type revenues), and ends with the tremendously insightful quote "People believe that these earnings are sustainable, but once these projects run out, First Solar will start losing money." I am still laughing at this quote as I write this article. You mean to say that, if a company doesn't sell stuff, they will lose money?? Wow!! I'm reminded of the very popular NFL analyst statement... "C'mon Man!" As of their last quarterly report, First Solar had close to $9B in forward projects, the overwhelmingly percentage of which has yet to be recognized. It goes without saying, of course, that First Solar has been, is and will continue to be, actively engaged in adding to this future revenue pool. Trying to suggest that their positive EPS over the past two quarters was only as a result of a revenue recognition policy, and is therefore not sustainable, would simply be erroneous.
3) First Solar, through its signed power plant contracts, has given itself plenty of time to enhance the power conversion performance of its photovoltaic technology. Even recently, First Solar has announced strategic partnerships to continue to enhance their existing programs. Given the resources at their disposal, and their obvious success in attracting new business, I see no reason to believe that First Solar's technology will fall out of favor in the short or long term comparative to the rest of the industry.
4) While Mr. Johnson warns of an impending cash flow crunch for First Solar, I think not. The first nine months of 2012 saw the company produce over $430M in operational cash flows, ending the third quarter with close to $720M in cash and equivalents and another $865M in current accounts receivable. It should also be noted that their current ratio of assets to liabilities sat at an extremely healthy 2.37:1 and their debt-to-equity ratio was an even healthier 0.73:1. Even if First Solar starts to accelerate the development of projects at a pace beyond which it can bill and collect from customers, (which is unlikely anyway), their cash and overall financial position is strong enough to allow them such flexibility.
5) As I said in my last article on First Solar, margins have appeared to stabilize in the mid-20% range. While not as high as the historical levels experienced prior to the industry over-supply issues, the company is able to make money and is on target to earn at least $4.75 per share for fiscal 2012 and more again in 2013 and beyond, resulting in a dramatic undervaluation when compared to today's trading value.
6) While there is certainly an inordinate amount of world production overcapacity within the solar industry, singularly focusing on issues relating to over-supply would be to ignore the growing sales trend and the success First Solar has experienced in this regard. In 2008, First Solar had $1.25B in sales, four years later, they are on pace to have close to $3.8B in sales for 2012, a more than 200% increase. Of course, sales mean nothing if you can't be profitable, which most companies within the solar industry are not. However, First Solar is not most companies. In 2008, the company had net income of $348M, then $640M in 2009 and $664M in 2010 before experiencing a net loss of $39M in 2011, their first loss since 2005 when they were essentially still a start-up company. Of course, in 2011 they took goodwill impairment and restructuring charges in excess of $460M. In 2012, they will, in all likelihood, have another net loss of approximately $70M, the result of which will include $475M in restructuring costs. Now that restructuring is substantially complete and goodwill impaired, return to substantial profitability for 2013 and beyond seems much more likely than not.
The fact is, First Solar continues to be presented as a problem-company by many analysts when providing negative commentary on the solar industry at large. While many investors have bought into the arguments, (based on the continually high number of shares held short), the current share price has been increasing for several months now, but still presents a very real opportunity for the investor looking for a mid to long-term value play.
Disclosure: I am long FSLR.