First Solar Vulnerable to a Big Selloff

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):

1. Net sales guidance range of $1.9 billion to $2 billion.
2. 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.

Comments

[Jasper M:]

Good article.
I mostly agree with the author.
I suspect silicon prices may fall faster than all expect, but I also expect power demand to fall off even faster.

Jun 14 06:25 PM

[kewlhand:]

And what happens if poly silicon prices have bottomed or heaven forbid start to rise??? First Solar regains it's competitive advantage and that would be reflected in it's stock price. So my assertion is that the future price of FSLR is directly linked to the price of poly silicon.

Jun 14 07:00 PM

[Alan Young:]

I appreciate the detailed analysis. There aren't enough in-depth examination of fundamentals on SA.

Jun 15 01:48 AM

[Roginfl:]

The solar industry may very well take a breather for a short while, but there is no denying the trend --and the potential for significant gains.

Jun 15 08:35 AM

[jbde:]

Wafer prices can come down with wafer producers [LDK] making their own poly-si. But FSLR cannot reduce prices and in fact may see its raw material prices go up.

Module makers still have to face costs of assemby, aluminum and glass. Mechanization favors lower ASP's, however the aluminum and glass components can fluctuate greatly [effects all producers].

Bottom line - solar market will broaden with lower ASP's for modules while all companies in the food chain reap profits. But FLSR has very little cost downside potential compared with LDK being able to pump out poly-si at a projected $30/kg after obtaining full ramp of it 15,000mt plant [2 yrs]. Other big players like, WFR, SOL, REC will also be able to lower wafer prices and thus help pure module makers enjoy lower wafer coss.

Jun 15 09:14 AM

[Idiotbuster:]

Polycrystalline silicon prices is coming down but I doubt that it will be available in ever greater quanitiies if ever.. The important indicator is availability. I am sure that FSLR will not stand still for long, it will make announcements of plant expansions like Intel did in the early years. Moreover, I am not fazed by the availability of grid capacity as countless small towns and hamlets will start investing in their own solar plants not only for their own uses but to use the local grid to sell back power. The possiblities is unlimited.. You see a lot of hills and they can be covered with FSLR modules before too long.. Wind power may remain bigger than photovoltaics, but I think that it will change as more localities would prefer photovoltaics over windpower.
Moreover, FSLR has already established recycling programs for returning solar modlues to be reprocessed. Recycling is already included in the price FSLR set for the new modules.. Can polycrystalline silicon be recycled? No one is mentioning that at all.. The photovoltaic industry has not cracked even ten gigawatt capacity in whole... I am talking about far more gigawatt capacity in the near future. It wont be long before we are churning out past one hundred , one thousand, ten thousand gigawatt worth of solar modules either with cadmium telluride or polycrystalline silicon. Everybody is welcome aboard, but FSLR will remain the Intel of photovotaics.. FSLR is a runaway phenomenon, already!! Too far ahead of the crowd for any competitor to catch up.. What is still bugging me the most is the yet to be announced new expansion of plant capacity by FSLR.. I am sure it is around the corner, anytime.. Thank you for your put options,, your loss will be our gain.. What a moron you are!!

Jun 15 11:03 AM

[Idiotbuster:]

Why did you censor my comment today??

Jun 15 11:28 AM

[Idiotbuster:]

never mind... it is back there after I complete my profile... thank you..

Jun 15 11:28 AM

[Idiotbuster:]

It is possible that FSLR has the most durable types of photovoltaics that is best suitable in the hot deserts where temperatures hit over 100F all day.. It is also said that FSLR modules start generating earlier in the mornings and later in the sunsets than polysilcion variety... I dont understand why no solar module is being set up on the slopes.. Wind power are commonly found on the slopes of hills. Cows would be delighted to find plenty of shade under the solar arrays out in the hilly ranches around small towns and hamlets.. Beef will taste better... huh?

Jun 15 11:33 AM

[Idiotbuster:]

The biggest mistake anybody can make is placing solar modules on roof tops as they will block sunlight that is needed to radiate buildings during wintertime.. But it will benefit during summertime. Shadows make buildings much colder indoors... You need every bit of sunblight hitting your building during winteritme. I cut down my tall Italian cypress trees that used to overshadow my house during the best part of the day. They are in the wrong place. There is places where it is unwise to place solar modules. I dont think that placing solar modlues on homes make much sense because inverters that is required to convert solar electricity back into the grid are very expensive for small installations. I predict that more towns and hamlets will form their own solar utilities and simply hook it up to the exisiting local powerline with minor modifications. I am somwhat less enthusiastic about huge solar installations out in the deserts unless a population center is nearby like Phoenix or Las Vegas. The sweet spot will be around one megawatt instalations almost everywhere.as it will require only about 5 acres to site one megawatt installation. There is plenty of unsold properties all over that can be bought for that purpose. One megawatt can create about $100 per hour in revenue based on a dime per kilowatthour. This is a good revenue for any small local government. Most local municipalities would be more interested in First Solar because of its recycling feature.

Jun 15 11:48 AM

[Idiotbuster:]

Nobody is talking about what homeowners will do with their photovoltaic modlues on their rooftops at the end of its lifecycle.. Do they take it down and recycle? Who wil pay for it?? Is polysilicon recyclable?? Why dont you answer me on that??? Recyclability is the key...

Jun 15 11:52 AM

[Idiotbuster:]

Do governments really look way ahead like twenty years down and thnk about the possbile problems being created there? I dont think people want to see polysilicoin junk being dumped in the garbage dump, do you? Or shpped overseas to Chinese dumps??

Jun 15 11:55 AM

[Road Runner:]

Idiotbuster said, "The biggest mistake anybody can make is placing solar modules on roof tops as they will block sunlight that is needed to radiate buildings during wintertime.. But it will benefit during summertime. ".

Please think through things before you post them. Are you not aware that the best markets for home roof top solar systems are in the South, especially the Southwest?! Have you ever visited the South in the summer? Air conditioning in the blistering hot 5 month summer is, by far, a bigger expense and concern than heating in the mild 2 month winter. I live in Dallas and I know people that have paid over $500 for one month of electricity in the middle of the summer. And, that is with a 12 to 14 cent per kWhr rate which is in the middle of the range in the US.

P.S. It’s going to be about 98 degrees today in Dallas. Just another standard day in the summer.

Jun 15 01:20 PM

[Road Runner:]

Idiotbuster said, " I don’t think that placing solar modules on homes make much sense because inverters that is required to convert solar electricity back into the grid are very expensive for small installations. ".

Another clueless comment on your part. Solar technology is changing rapidly and the cost is dropping quickly for all components for a home solar system. Much of this is because there was little direct investment in solar technology during the 1980s and 1990s because of very cheap oil prices. But, in that time, there have been huge advances in basic technology like power switched diodes, transistors, capacitors, etc. Thus, development of “solar microinverters” is progressing very rapidly.

Below is a section of the article at www.greentechmedia.com.../

“But a growing number of solar companies are offering microinverters that are attached to each panel or a small rack of panels, an approach that is better suited for residential and small commercial installations where they are more likely be placed close to trees and next to other buildings”

Jun 15 01:41 PM

[buyforeclos...:]

all solars are overpriced...

Jun 15 04:53 PM

[User 79512:]

Steve

FSLR has an impressive track record but they aren't the only game in town. Hemlock et. al didn't expand Si production on a whim. LDK and company didn't build out wafer capacity with the expectation of losing money. STP didn't build a 1 GW production facility for the heck of it.

Wafer ASPs back in 2000 were as low as $.92 and I suspect wafer prices will return to these levels by the end of 2009. That puts best of breed Si PV at $1.50-$1.75/Watt by the end of the year. As silicon heads back towards $30/kg, wafer thickness trends down to 150 um, efficiency trends upwards and processing costs continue to improve Si based PV will head steadily towards $1/Watt.

First Solar predicts best of breed Si PV reaching $1/Watt in 2012. This is a reasonable prediction. Surprisingly, FSLR assumes Si module efficiencies of 14% in this timeframe. FSLR assumes this spread (14% efficient Si vs 12% efficient CdTe) translates into a $.15/Watt balance of system penalty for CdTe panels. Wait a second? What if Si is 16% efficient? Seems like this would be a $.30/Watt advantage. Poof... there goes First Solar's lead. Will FSLR stand still and let Si run them over? I don't think so but they can't just keep doing what they've done. The earnings they should enjoy over the next few years gives them many choices. FSLR has surprised us so far so it's hard to predict what they'll do moving forward.

Jun 15 10:35 PM

[Windsun33:]

The life cycle on silicon panels is 50+ years, possibly longer than the life of the house. You are wrong on most of your other points also, but I don't really feel like getting into it here.


On Jun 15 11:52 AM Idiotbuster wrote:

> Nobody is talking about what homeowners will do with their photovoltaic
> modlues on their rooftops at the end of its lifecycle.. Do they take
> it down and recycle?

Jun 16 10:06 AM

[Windsun33:]

"...First Solar is the number one solar energy company in the world.."

Actually it is not. Perhaps the #1 non-silicon one, based on the inflated market cap due to far too high P/E. Far too many have bought into that "$1 per watt" hype, when in fact the cost is about twice that, and the installed cost is close to $5 per watt - only about 10-15% less than silicon panel installations. And Si prices are dropping. When FSLR first started hyping the $1 per watt, Si panels were selling for around $5 per watt, now they are approaching $2.50 per watt, and take up half the space.

The one thing that really bothers me about the FSLR panels is that they have a very short time in the field so far, and the failure rate is unknown - but historically thin film panels have been more failure prone than Si.

Jun 16 10:14 AM

[john12345:]

I dropped out of the solar investing opportunity a long time ago after having won and lost with both FSLR and LDK. My memory is that business was great primarily because of government subsidy in European countries and elsewhere. They couldn't compete with conventional sources economically. Also, the supply of telluride was questioned since it is very rare. Have these issues gone away?

Jun 16 07:25 PM

[paultheprofit:]

"" What a moron you are!!""

I think the poster that wrote this...really NEEDS to BUY himself a MIRROR and then proceed to LOOK at it...then the ABOVE quote will BE ENTIRELY CORRECT!

Jun 17 06:33 AM

[paultheprofit:]

"" What a moron you are!!""

I think the poster that wrote this...really NEEDS to BUY himself a MIRROR and then proceed to LOOK at it...then the ABOVE quote will BE ENTIRELY CORRECT!

Jun 17 06:33 AM

[Idiotbuster:]

Air conditioning users can install room air coniditoiners to cool only one or two rooms instead of the whole house and cut down on thier utility bills. I did that and I am enjoying great savings. Small investment and Big returns in savings. Save your central AC for wild parties of 30 people crammed in your house .. Also , I shield my brick fireplace with brick chimney with aluminium foil covered plywood boards to reflect back the sunlight so that the bricks do not absorb heat and radiate heat indoors. It works like magic! I am pretty comfortable in the hot California climate. Why dont you think of that yourselves, huh??????????????? The rest of the house disspiates heat quickly after sundown but not the damn chimney made of bricks!! Stupid bricks!

On Jun 15 01:20 PM Road Runner wrote:

> Idiotbuster said, "The biggest mistake anybody can make is placing
> solar modules on roof tops as they will block sunlight that is needed
> to radiate buildings during wintertime.. But it will benefit during
> summertime. ".
>
> Please think through things before you post them. Are you not aware
> that the best markets for home roof top solar systems are in the
> South, especially the Southwest?! Have you ever visited the South
> in the summer? Air conditioning in the blistering hot 5 month summer
> is, by far, a bigger expense and concern than heating in the mild
> 2 month winter. I live in Dallas and I know people that have paid
> over $500 for one month of electricity in the middle of the summer.
> And, that is with a 12 to 14 cent per kWhr rate which is in the middle
> of the range in the US.
>
> P.S. It’s going to be about 98 degrees today in Dallas. Just another
> standard day in the summer.

Aug 14 06:25 PM