First Solar (FSLR) released its 4th quarter and full year 2012 financial results after the bell Tuesday and, just like last time, there was a resounding thud. As investors may recall, FSLR released 3rd quarter results after the bell on Nov 1st, 2012, a day in which $24.75 was the closing price per share. The next day, investors pounded the shares with an intraday low of $22.20, (a decrease of 10.3%), before ending the day at $22.54, down close to 9%. Obviously the share price rebounded as investors came to realize the overreaction. Had investors recognized the buying opportunity created and bought the day after the 3rd quarter earnings release, they could have provided themselves with a very healthy return. The question now becomes, has history repeated itself, giving investors yet another opportunity to take a long position in the days after the earnings release? To answer this question, we have to once again determine whether First Solar remains a strong and viable company which continues to be undervalued, or does the 4th quarter earnings report provide insight that makes First Solar less valuable than perhaps some investors thought.
Let's look at First Solar's book value and earnings relative to its market capitalization.
At its most fundamental measure, share price is looked upon as a multiple of earnings per share, or EPS. The reason for this is obvious, if a company cannot make money, nothing else really matters. Who really cares if you reach record sales volumes if you continue to lose money. Anyone can give away product and services at a loss. To the degree a company has consistently made money in the past, it will have retained earnings and therefore have a positive equity position in its capital assets, likely resulting in a reasonable book value. Conversely, accumulating losses will erode overall capital and can eventually put a company into a negative equity position once the losses surpass capital contributions from share sales and the like. Essentially, the share price will be reflective of a combination of past performance and what investors deem to be the company's ability to deliver positive earnings in the future, (i.e. the pps always contains a component of current book value based upon past performance).
In the case of FSLR, total equity, (or book value), at December 31, 2012, was a very healthy $3.61B (or 56.9% of total assets), including retained earnings of $1.53B. Forgetting First Solar's future earnings potential for a minute, I would urge investors to compare the current book value to its current market cap. As you will see, the market cap is trading at approximately 65% of its book value, which has truly dropped below even its salvage value. Want more evidence of this? As I write this article the intraday low has now dropped to $25.50, making the market cap $2.27B. Per the quarterly report, First Solar has $1.96B in cash, marketable securities and receivables alone, while having $2.83B in current assets only. As such, not only is the company undervalued relative to its book value, it can be argued that investors are placing not even $1 of value on inventory, prepaid expenses or capital assets, while giving the company no credit for any type of future earnings potential whatsoever. If you believe the company can and will make money in the future, (even if not at the same level as the past), while its current value is at least close to book value, then this becomes the very definition of being dramatically undervalued. Seriously, the company is now valued at more than $500M less than its CURRENT assets. Really? Before I write anything further ... just on this basis alone, my advice is ... BUY!
Recently, I wrote an article comparing First Solar to the solar industry. Well, if you want a comparison with regard to values, look no further than SunPower (SPWR), the world's second largest solar company. SunPower recently released its 4th quarter and year end results which indicate they have a total book value of $993M (or 29.6% of total assets), including an accumulated deficit of ($902M). Interestingly enough, SunPower's current market cap trades at 150% of its book value, even though, ironically, they've provided much weaker guidance for the upcoming first quarter than First Solar. In fact, SunPower has outlined that they will experience between a ($0.60) and ($0.85) loss per share on sales having 3-7% margins in the first quarter, while First Solar has indicated they will experience positive earnings per share between $0.70 and $0.90 on sales having 25-27% margins. This means that First Solar has clearly articulated that it will be adding to its current book value in the first quarter, while SunPower will continue to erode its book value.
The fact is, at the current market cap, First Solar is priced as if it were going to go bankrupt. As such, investors have placed full value on the most liquid of assets, (which is to say its $1.96B in cash, securities and receivables), have applied an approximate 50% discount rate to the remaining $4.4B of other assets, (including inventory, property, plant and equipment), and have priced debt at 100%, thus resulting in the current market cap. Given all information, does this make sense?? Short answer ... no.
First Solar is being punished for not living up to analyst expectations. Even though at Q3, First Solar beat consensus earnings estimates, it was a sales miss and lowered full-year guidance that seemingly caused a sell-off after their earnings release. Analysts like Cowen and Co.'s Robert Stone went on record as predicting "much lower" margins in the fourth quarter, something we now know did not occur given the company's healthy 27.3% margins, (the third quarter in a row margins have been between 25.5% and 28.5%). This quarter, it appears to be the same combination of missed sales and lowered guidance versus analyst expectations. So, First Solar did not meet sales guidance or consensus estimates, so the stock is selling off, even though they beat earnings estimates by a long shot. I'm sorry, in what world is a company valued on its sales? Again, anyone can sell products and services at a loss, there's nothing special about that. I would much rather see steady sales with a healthy bottom line than booming sales resulting from discounted prices and lowered margins leading to massive losses.
That said, what about First Solar's sales? Well, in 2008 they had $1.25B in sales, and in 2012 they had $3.37B, an increase of 170% in just four years (which includes a healthy 21.7% increase from 2011's $2.77B in sales). I'm not sure what investors are looking for in this regard in order to price the stock above its book value, but I have to think that whatever it is, SunPower is immune to the same train of thought. In SunPower's case, 2008 saw sales of $1.44B, (meaning it had $200M more sales than First Solar), versus 2012 sales of $2.42B (now more than $1B less than First Solar). With regard to SunPower's 2012 sales, it represents a paltry 2.1% increase from 2011. Even in light of this obviously lackluster historical performance, SunPower is valued at 150% of its book value, meaning not only are investors giving it full credit for 100% of all assets, but are placing a fairly large value on its ability to deliver future profits (which surely won't be happening in the first quarter of 2013 based on their guidance for an operational loss as pointed out earlier).
So, even though First Solar is healthy financially, having close to $2B in cash and receivables, has increased sales dramatically year over year since 2008, has built up over $1.5B in retained earnings, (even after taking close to $1B in goodwill impairment and one-time restructuring charges over the past 18 months), has leveled off its profit margins to 25-28% where it can make a very healthy bottom-line and, over the past two years, has completely refocused its business on the much more lucrative industry of mass scale solar projects, investors continue to pound the share price down to salvage value, even after the share price had only recovered to a market cap not even within $800M of its book value. It makes no sense.
It seems now that investors and analysts are placing a lot of emphasis on First Solar's forward sales bookings, noting that they fell 15% year over year. On the conference call February 26th, First Solar CEO Jim Hughes said the company would be looking to add to the backlog on a dollar for dollar basis "at the very least" as current projects were recognized as revenue. A Barron's article published on February 27th quotes analyst Ben Schuman of Pacific Crest Securities LLC reaction as "the goal indicates that the company will be treading water as it completes large power projects and seeks to develop new ones, and it may have trouble even meeting that goal." Talk about a negative spin.
The fact is, First Solar had a backlog of $9.4B to start the year and ended the year with $8.0B in forward sales. They recognized $3.4B in sales and added $2.0B to the backlog, thus the decrease of $1.4B. Let's assume for one second that First Solar will not meet its stated goal of keeping the backlog at $8.0B, and rather has it slip $1.0B per year while maintaining current sales levels (i.e. - no growth in sales). It would take 8 full years of $3.4B per year of sales before the backlog is gone, all the while the company would have earned more than $400M per year for those same 8 years, (assuming current margins and operational costs). That's an additional $3.2B of book value created to go along with the current $3.6B, making it close to an $8.0B company.
Today's market cap is approximately $2.3B. There is literally no value whatsoever being placed on the forward sales bookings ... none. Given the lack of value being placed on future sales and profitability, it almost makes corporate guidance irrelevant. That said, if you listen to their fourth quarter and full year earnings release conference call, you'll hear CFO Mark Widmar talk about expected sales and profitability as it relates to 2013. While not providing any great level of detail beyond Q1, he does state that the company expects to see "financial and operational results improving from Q1 to Q2." As for the remainder of the year, while he does explain that the second half "could" see lower profitability due to the sales mix between 3rd party modules and system project sales, he clearly states that they are in the midst of "evaluating, negotiating and developing a number of transactions or market opportunities which, if transacted, could materially impact our 2013 guidance." Now call me optimistic, but this clearly indicates that his comments regarding the second half sales and profitability are overly cautious given the transactions he has referred to will only materially impact guidance "if transacted", (i.e. - there is upside).
In following First Solar, another major issue that continually comes to the surface is certain analysts opinions as it relates to thin-film technology, specifically CdTe's conversion efficiency and what some feel is First Solar's slipping price competitiveness and IRR for customers. It was recently announced that General Electric (GE) had set the new world record for conversion efficiency, leaving some investors and analysts having the false assumption that First Solar was falling behind the competition in this regard. Two things I have to say about this; 1) Given GE's interest in CdTe technology, it's fair to say that they for one believe there's a future for this type of solar panel and 2) First Solar has since gone on to beat GE's record, as detailed in the supporting slides to the quarterly earnings release. The fact is, the debate over which technology is better provides a better IRR and pays back quicker will, with every certainty, continue to rage on. What's important to me is that First Solar is not standing still. Over the past number of years they have invested hundreds of millions of dollars in R&D which continues to increase the conversion efficiency of the solar panels while driving down the cost per watt produced. While the cost to produce silicon based photovoltaic solar panels continues to decrease, this is beginning to level out and is still not as inexpensive as First Solar's technology. To the degree that First Solar has to become more price competitive, they have the gross profit margins, operational structure and financial flexibility to do just that. They are, by far, in the best position to compete out of any solar company in the world.
So, where does this leave us? Well, as announced on the conference call, there will be an Analyst Day on April 9th in which First Solar will give updated financial and operational guidance while detailing their competitive positioning and technology road map. In the meantime, I would suggest that any investor thinking FSLR is overvalued, think again. This is a very solid company whose market cap is priced for insolvency. If you think they're going bankrupt, don't invest. I for one believe otherwise and see this as a huge value play.
Disclosure: I am long FSLR.