Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of First Solar (FSLR) in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess the financial condition of First Solar. The information that I am using for this article comes from First Solar's most recent financial reports, which can be found here. Note that this article is not a comprehensive review as to whether First Solar should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
First Solar manufactures and sells photovoltaic solar modules, using advanced thin-film semiconductor technology. These solar modules convert sunlight into electricity. The company also designs, builds, and sells photovoltaic solar systems that use the modules that the company produces.
First Solar's business is split into two segments. They are Components, and Fully-Integrated Systems. The Components segment designs, produces, and sells the solar modules to project developers, system integrators, and operators of renewable energy projects around the world. These customers then either resell the modules to end users or integrate them into solar power plants that they either own, operate, or sell. Major customers in this segment include utility companies, like NRG Energy and Exelon Corporation.
The Fully-Integrated Systems segment provides complete turnkey photovoltaic solar power systems that use the modules that the company produces. This segment also includes project development, engineering, procurement, and construction services, operating and maintenance services, and project finance expertise. Customers of this company's business segment include investor-owned utilities, independent power developers, and commercial and industrial companies. NRG Energy and Exelon are also major customers of this business segment.
In the company's 2012 10-K filing, First Solar mentioned that NRG Energy, Exelon, and MidAmerican Renewables, LLC each accounted for more than 10% of their 2012 sales. During 2012, the Fully-Integrated Systems segment accounted for 65% of sales, while the Components segment contributed the other 35%.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
As of June 30, 2013, First Solar had $1.29B in cash and short-term investments that can easily be converted into cash. Their short-term investments include corporate debt, foreign government and agency debt, as well as federal agency debt. This is a lot of cash for a company that has a market capitalization of $5.19B. This means that the company is trading at just 4 times its cash position, which might make the stock very attractive to value-oriented investors.
Over the last 12 months, the company generated $385M in free cash flow.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
First Solar had a total of $653M in net receivables on its most recent balance sheet, which represents 20.5% of its trailing 12-month sales of $3.19B. For fiscal 2012, 28.3% of its sales were booked as receivables, while that percentage was at 30.5% for fiscal 2011.
These are high percentages for receivables, but this is common for long-term construction contracts, in which First Solar is regularly involved, where revenue is often recognized before the customer is even billed. It is encouraging though, that this percentage has been trending downward over the last couple of years. Investors should continue to monitor this figure as the years and quarters progress.
With manufacturing companies like First Solar, I like to keep an eye on inventory levels. I usually like to see inventory levels stable or slightly rising from one year to the next. If I see inventory levels rising, then I want to see revenues rising as well, to indicate higher demand for the company's products. I don't like to see rapidly fluctuating inventory levels that are indicative of boom and bust cycles. In some instances, if inventory ramps up without increases in volumes or revenues, then it may indicate that some of the company's products are going obsolete.
As of June 30, 2013, First Solar had $334M worth of inventory, which amounts to 10.5% of the company's sales for the last 12 months. At the end of fiscal 2012, this level was at 12.9% of sales, while at the end of fiscal 2011, it was at 17.2% of sales. If you go back to the end of fiscal 2010, inventory levels were equal to just 7.65% of the company's sales for that year. In 2011, there was a sharp spike in inventory levels, without much of an increase in revenues. This is not what we as investors like to see. However, this percentage has been trending down since 2011, and there does not appear to be a glut of inventory at this time.
Of the company's $334M in current inventory, 60% of it is in finished solar modules, while the remaining 40% is in raw materials.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of First Solar is 1.95, which is very good.
Most of the time when it comes to short-term liquidity, I end the discussion at the current ratio. However, with companies that have a large chunk of their current assets in inventories, one has to wonder whether all of that inventory can quickly be converted into cash in the event that the company suddenly needs it. Some of the inventory might be obsolete, or have to be disposed of for less than it was originally valued at. Given that inventories currently constitute nearly 10% of First Solar's current assets, this is a valid concern here.
To address this issue, I calculate what I call the quick ratio. The quick ratio is calculated simply by subtracting the inventory from the total current assets and then dividing the remainder by the current liabilities. I usually like to see a quick ratio of at least 1.0. That way, even if the company's inventory is worthless, they will still have enough other current assets on hand to meet their short-term financial obligations in the event of an unlikely disruption to their operations.
The quick ratio of First Solar is 1.77, which is outstanding. This means that even if their inventory is all written off as worthless, they should still have enough current assets on hand in order to cover their short-term financial obligations.
Property, Plant, and Equipment
For manufacturing companies like First Solar to operate, a certain amount of capital expenditure is required. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant, and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage. However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors.
Right now, First Solar has $1.56B worth of property, plant, and equipment on its balance sheet. This figure is inline with the $1.53B that it reported at the end of fiscal 2012, and below the $1.82B that the company reported at the end of fiscal 2011. In its 10-K filing, the company said that 68% of these assets are in machinery and equipment, while 19% is in buildings, with construction in progress and office equipment each accounting for 5% of the company's PP&E assets.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher the better, although lower returns due to large asset totals can serve as effective barriers-to-entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = Net Income / Total Assets.
For First Solar, the return on assets would be $389M in core earnings over the last 12 months, divided by $6.57B in total assets. This gives a trailing twelve-month return on assets of 5.66%, which is decent. I also calculated First Solar's returns on assets over fiscal 2012, fiscal 2011, and fiscal 2010 for comparative purposes. This can be seen in the table below.
Table 1: Declining Returns On Assets At First Solar
Here, we see that First Solar's returns on assets have been in sharp decline over the last couple of years. This is due to declines in earnings that the company has been experiencing over this time frame, coupled with expansions in the asset base. The declines in core earnings that we have been seeing here are due to decreasing gross margins that are brought on by higher costs of goods sold. These higher costs stem largely from increased construction costs due to an increase in the number and size of utility-scale solar power systems under construction. Lower pricing and volumes of modules sold to third parties have also contributed. It should be mentioned that the company actually reported negative GAAP earnings over 2011 and 2012 due to restructuring charges, goodwill impairments, and warranty-related expenses.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
Fortunately, this is not a much of a problem for First Solar, as they only have $61.2M in short-term debt, which the company can take care of with its free cash flow generation.
Long-term debt is debt that is due more than a year from now. However, an excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, First Solar carries $195M of long-term debt. This is well below the $500M that it carried at the end of fiscal 2012, as well as the $619M that they carried at the end of fiscal 2011. This shows that the company has been paying down its debt, which is great. It should be mentioned that all of this debt is due within the next five years, starting in 2015. However, the company's free cash flow, as well as existing cash position should be able to take care of this without a problem.
In determining how many years' worth of earnings it will take to pay off the long-term debt, I use the average of the company's core earnings over the last 3 fiscal years. The average core earnings of First Solar over this period is $539M. When you divide the long-term debt by the average earnings of the company, here is what we find.
Years of Earnings to Pay off LT Debt = LT Debt / Average Earnings
For First Solar, here is how it looks: $195M / $539M = 0.36 years
This is great for First Solar, in that it can pay off its long-term debt with an amount that is equal to less than one year's worth of core earnings. Due to the core earnings power and cash flow generation of First Solar, the company's long-term debt should definitely be manageable.
The debt-to-equity ratio is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how First Solar stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For First Solar, it looks like this: $2.71B / $4.16B = 0.65
In the table below, you can see how this ratio has changed over the last few years.
Table 2: Debt-To-Equity Ratio At First Solar
In Table 2, we see that First Solar's debt-to-equity ratio took a bump up in 2011 and has remained there since. However, overall, the debt-to-equity ratio at this time is low enough, so that it shouldn't be a problem going forward.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholder Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks.
However, First Solar is not one of these companies. The return on equity for First Solar over the last 12 months is equal to $389M in core earnings, divided by shareholder equity of $4.16B, which is equal to 9.35%.
To illustrate how the returns on equity of First Solar have changed over the last few years, I have created the table below for the return on equity.
Table 3: Returns On Equity At First Solar
As was the case with the company's returns on assets, the returns on equity have been in decline due to declines in the company's core earnings, along with a strengthening equity position.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
On its most recent balance sheet, First Solar shows a retained earnings figure of $1.53B. In the table below, you can see how this figure has grown over the last three years. Over this time period, we see that retained earnings grew at a cumulative rate of 53%. The retained earnings jumped by 67% during 2010, but then fell a little bit during 2011, and then fell some more during 2012. This drop is due to the company reporting negative GAAP earnings over 2011 and 2012 for the reasons discussed earlier in this article.
Table 4: Retained Earnings At First Solar
After reviewing the most recent balance sheet, there are a few things to like about First Solar's financial condition. One is the fact that the company has a sizable cash position, which might make the stock attractive to value-oriented investors. It also gives the company flexibility when it comes to paying down debt, buying back stock, and paying dividends. The company has outstanding current and quick ratios, which show that First Solar should be able to meet all of its short-term financial obligations in the event of a sudden disruption to its operations. The company's debt, both short term and long term, are very manageable, as can be seen from its low debt-to-equity ratio.
The one thing that concerns me the most about First Solar is its earnings, which have been in steady decline over the last few years. This has resulted in the company reporting declining returns on assets and equity. If this trend continues, then we can expect the financial condition of First Solar to deteriorate, as the company will need to rely more on debt and stock issuance in order to continue operating. This is probably at least part of the reason why the stock is trading at just four times the company's cash position. The company is scheduled to report its latest quarterly earnings next week, and hopefully, they will give us further insight as far as where they see earnings going in the future.
To learn more about how I analyze financial statements, please visit my new website at this link. It's a new site that I created just for fun, as well as for the purpose of helping others make good financial decisions.
Thanks for reading and I look forward to your comments!