The One Liner:
First Solar (FSLR) faces the daunting pressure of acquiring new customers in new geographies (U.S.) as the quality of existing consumers declines and as ongoing industry pricing pressures on polycrystalline silicon increase.
Summary:
First Solar is the number one solar energy company in the world. Calling for a short-sell/sell recommendation on the top player in any industry would seem to be both risky and foolish.
However, FSLR is a "new" commodity company in an industry that is too richly valued. Its declining cost-management supply business model, while unique and impressive, is not sufficient to justify a high multiple. A high trailing P/E was justified by lower product pricing, healthy customer demand, and government policies resulting in a net 10-fold revenue growth. Past results don't justify future results.
In this research report, I will illustrate why investors should should short FSLR at current prices.
Balance Sheet Analysis:
Earnings Per Share - 5 Year Period
- 2008; 2007; 2006; 2005; 2004; 2003
- $4.24; $2.03; $0.07; $(0.13); $(0.39); $(0.78)
Analysis: EPS sky rocketed in 2007 and in 2008 alongside impressive growth in revenue. Compared to 2006, revenue rose almost 500% in 2007, and almost 10,000% in 2008. This was achieved when FSLR lowered reached a critical price/megawatt. The issue now is that its competitors are making the same achievements, decreasing the competitive advantage the company has in this industry.
The average EPS for the 5-year period is $1.01. This is calculated to estimate the company value so that it may be compared against the current market share price. Next, applying a a variety of forecast growth rates we arrive at a range of values:
Growth - Company Value:
- 200% growth - $412.585
- 100% growth - $210.585
- 75% growth - $160.085
- 50% growth - $109.585
Note that the company is still nascent as a public company, so these estimates have minimal reliability.
At a current share price in the ~$180s, if the company disappoints by failing to meet projected growth, the downside 2009 valuation for FSLR is $109.69 - $160. This downside is greater if market discounting is applied. Historically speaking, the green initiative/movement by the government (especially with Obama) added to this "market premium" on the stock price. See the chart and the stock price around the time of the U.S. election (here).
Conversely, FSLR could be worth $412 if it produced 200% returns indefinitely and in a current and future economic environment equivalent to that of 2007-2008. How can any investor assume a 200% growth rate when PV prices are falling and new demand is waning? Note that FSLR has an impressive backlog in orders, but as it will be discussed, 10-15% of those orders face credit risk.
To put it succinctly, FSLR is at best at fair valuation (a market assumption for 100% growth indefinitely) and at worst has more downside than upside.
Company Forecast (Key Figures):
- Net sales guidance range of $1.9 billion to $2 billion.
- GAAP operating margin between 31% - 33% (expenses for OptiSolar acquisition is factored in this)
Source: SeekingAlpha.com
The "street" is forecasting an EPS for 2009 is $5.66 and for next year it is $8.91.
I plotted the EPS estimates for 2009 and 2010 against past earnings from 2003. The forecast figures were obtained from Finviz.com: it was a proportionately straight line! That's right. I used an exclamation point in this research report.
If forecasting was this easy, then I would cast the EPS estimates for FSLR, and its current share price, in doubt. The forecasts likely assume recurring revenue and margins are constant, a scenario that needs to be questioned. There is clearly more downside remaining with FSLR.
Let us now dig deeper on to the facts to put into question the validity of the future earnings estimates.
Financial Ratios:
The Good:
- Debt/Equity: 0.14
- EPS This Year: 5.66
- Market Cap: 15.77B
- ROE: 32.64%
- Insider Ownership: 42.94%
- Sales past 5 Years: 229.48%
The Forecast:
- EPS Next Year: 8.91
- Fwd P/E: 20.96
The Bad:
- Book Value/Shr: 20.84
- P/E: 32.99
Figures from Finviz.com
Discussion of Forecast
In its most recent conference call, management repeated many times that it would need to cut costs and improve margins to meet this consensus growth already priced in by the market.
Are the forecast earnings this achievable? This is questionable for two reasons. The questions lie in two general areas: (1) recent quarterly results and (2) fundamental analysis. I will not detail a balance sheet analysis since the metrics are healthy.
(1) Quarterly Results
Briefly, in its most recent quarter, revenue was $418.2M, translating to a diluted EPS of $1.99. These were solid results.
Remember that the key metric in this industry is production amount (megawatts). For FSLR, the company generated 26% more at 220 megawatts. That's up 26% quarter-over-quarter. Capacity/line was up 49 megawatts, up 4% quarter-over-quarter.
The company signed up 479 megawatts in new volumes, with gross margins at 56.3% (up 2.4%). In its conference call (posted on seekingalpha.com), gross margins were sustained by the use of foreign exchange hedges.
Investors need to be aware that these hedges are for 2009 only, and therefore earnings will fluctuate with the Euro. While I am not bullish on the Euro (see here), investors will need to watch more closely the gross margins with FX affects stripped out.
Finally, cash flow at $63.7M sounded healthy. Still, management indicated an increase in accounts receivable and in inventory. If customer accounts show signs of strain, it will further solidify my view on FSLR. For example: year over year, receivables are up ten-fold, and inventory is nearly double. For now, however, it is not a major negative concern in my bearish view for the company since these values are large in percent change, but small in absolute dollar terms.
Investors will need to monitor changes in these two lines on the accounting sheet.
(2) Fundamental Analysis
The PV-specific pricing trend is worrisome for this industry. It is not unnatural for new sectors who experience lower sale price for products due to competition, supply increase, and technological improvements in manufacturing.
However, just how much of demand was due to subsidies from "green" initiatives? FSLR benefited from this in European markets, and is currently pushing into the Americas. More specifically it is pushing into California. This is the state with a government facing massive deficits, problems in its cash flow, and severe problems in the housing market.
To establish a position in the U.S., FSLR needs to 1) obtain incentive from the federal government (subsidies) and 2) natural gas prices must rise.
Geographically, there are constraints. Just where will transmission lines be placed?
Is it possible to develop conventional power projects alongside solar power ones? There aren't even any guidelines or rules established for this. How long is this going to take? That will add to uncertainty to the stock price, if U.S.-based growth is priced into the stock.
Another worry for FSLR is its EXISTING customers. The company is seeing up to 10-15% defaults. Therefore, the market price of FSLR is dependent on the perceived health of the economy and the banking/credit system. Any more bad new in these areas (which I believe will be coming - see my blog) will push FSLR stock price down. So, if management is cautious with its customers, why are shareholders rewarding FSLR with a rich current P/E of ~30x ?
One thing I like about the company is that it manages its forecasts assuming declining polycrystalline silicon costs. the company compares it to its own cost reduction road-map. That way the company can manage its margins against cost advantages.
No wonder FSLR is #1 (the company sees a manufacturing cost at ~$0.65 a watt by 2012, translating to a 35-55% cost advantage).
Another "positive" for FSLR is high natural gas prices. Right now it is low (relative to oil prices). I believe that oil prices are up only due to currency/money flow, and not due to demand/consumption dynamics. Therefore, natural gas prices will remain low. This is negative for FSLR. (See here.)
Conclusion:
I am skeptical that the company will be able to achieve 200% sales and earnings growth for the next 5 years, while maintaining margins in the absence of currency hedges beyond 2010. My price target is $110, based on a projected growth rate that is 4-fold less than the street view.
This is a 40% decrease from current levels. I plan to increase my SHORT position by up to 10% as political, economic, and fundamental changes prove my investment thesis correct.
Risks to Price Target:
Due to positive correlation to commodity pricing, especially oil, commodity strength is a risk. Risk exists for competitor polysilicon prices to fall, undermining FSLR's low-cost production advantage.
Disclosure: Author holds a short position in FSLR on his KaChing virtual portfolio (a site with over 370,000 registered users). This portfolio is also followed by nearly 400 users.
