First Solar, Inc. (FSLR) has declined 58.68% year-to-date (as of 10/21/11) underperforming the -1.54% return of the S&P 500 (SPY). Although FSLR has fallen to price multiples that many investors may find attractive, FSLR may also be at its current price for a good reason. First Solar has displayed low earnings quality for 2011 and faces significant risk of future downward pressure on earnings.
Poor earnings quality as measured by The Accrual Review - My company, The Accrual Review, gives First Solar an F rating for the first half of 2011 based on FSLR’s above-market balance sheet accrual growth (earnings quality ranked bottom 5% of S&P 500 “ex-financials” companies). High growth in balance sheet accruals is predictive of low earnings quality and increased risk of earnings reversion / restatements.
Accounts receivable and inventory increasing faster than peers – Two components of balance sheet accruals are accounts receivable and inventory. For the first half of 2011, First Solar appears to have aggressively accounted for these two categories:
- Accounts receivables increased by 98% Q2 2011 from Q4 2010 (highest among of peers)
- Inventories increased by 61% Q2 2011 from Q4 2010 (highest among of peers)
- Sales decreased by 13% Q2 2011 from Q4 2010 (7th percentile of peers)
Aggressively accounting for accounts receivable will overstate sales for the period. This is particularly alarming when sales are concurrently declining as is the case for FSLR. Additionally, FSLR’s Days Sales Outstanding rank at the 80th percentile of its peers. All of these together suggest that FSLR’s current earnings are poor quality.
Overstating inventories decreases cost of goods sold and increases operating income for the period. This increases the risk that FSLR may have to lower prices to push through excess inventory in the event of a slowdown.
Because FSLR’s growth in both accounts receivables and inventories is above peers, this raises concern for FSLR’s earnings quality and earnings persistence factor.
Data from Yahoo! Finance
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.