First Solar: Terrific Earnings, But Enormous Multiple

Last week investors were treated to yet another earnings announcement from First Solar Inc. (FSLR) stating that the company is growing sales at a tremendous rate and that profits reached a new record. Management wowed analysts by stating that new production capacity would come online sooner than expected thus having a positive impact on next years number of megawatts produced (see First Solar, Inc. Q4 2007 Earnings Call Transcript). The number of customers doubled over the last year with a grand total of 12 clients, with long-term contracts now stretching out into 2012 representing over 3 gigawatts of production. On the surface everything looks splendid.

As might have been expected, traders celebrated the news by pushing the stock higher - adding over 50 points in a single day. Very few want to sell stock in a company that is growing sales at 281% year over year and increasing production at such a solid clip. The news is likely to continue to be good as management stated that the three additional plants in Malaysia are on schedule to be completed according to previous guidance with all plants online by the fourth quarter of 2009. The result will be an annual production rate of roughly 1 gigawatt once all facilities come online.

Despite all the good news embedded in the announcement, and the analysts who trumpeted another business success, there appears to be a few items of concern when digging deeper into the details. First of all, the company noted that this quarter represents a steady state quarter with the full benefit of capacity online with no ramp up costs. This is a sophisticated way of saying that everything was operating as good as it gets. In the future, ramp up costs will likely bite into profits making last quarters feat harder to duplicate. A second issue is that the company has benefited significantly from a rise in the Euro last year. While this is not atypical of many international companies, I was surprised to note that a very large portion of the revenue increase was due more to currency issues than actual higher sales. While still impressive, this fact takes some of the hit out of the blowout revenue numbers.

Management spent some time on the conference call outlining their future focus on Return on Net Assets [RONA] as a primary metric, replacing their previous focus on operating margins. There is nothing inherently wrong with this issue except for the fact that it doesn’t take too much thinking to realize that the future margins will be squeezed as pricing for the end products will likely drop more quickly than the efficiency gains the company is seeking in the production process. It is wise for management to prepare the investor base for this fact, but as margins become compressed during the course of 2008, the likelihood of the stock multiple declining is very great.

The company has a very concentrated presence in Germany where subsidies have driven strong demand for solar products. First Solar understands that it needs to branch out into new markets if it will survive in an increasingly competitive market. While goals have been set to deliver products to markets with little or no subsidies driving demand, the words must be backed up by action in order to gain credibility. If selling to free markets becomes a more difficult process than previously expected, the exponential ramp in production capacity could end up being a huge gamble lost with large capital investments sitting idly by.

The most difficult issue to consider when investing in FSLR is the enormous multiple on the stock right now. Even considering CSFB’s optimistic estimate for earnings of $8.75 in 2010 (that’s right - they have estimates that far out), the stock still trades at a 24 multiple to these three year projections which assumes 83% compound annual growth of earnings. These are staggering numbers and looking back in history, there are very few times when such overarching investor optimism turns out to be a wise buy. The deck seems stacked against shareholders at this time, not due to the inadequacy of management or the strength of the company, but simply due to the unbridled enthusiasm of investors. The greed of Wall Street is a powerful force and there are no guarantees that this force will not push the stock higher in the short run. However, the wise long-term strategy appears to be to wait for a better entry point at a lower price, or to potentially short the name in conjunction with a lower multiple stable competitor.

FSLR Notes

FD: Author does not have a position in FSLR

Comments

[Timmothy Posey:]

I'm still in the "Short of the Year" camp for this stock. Too much hot money trying to chase past returns. And also too high of expectations. Even if the company simply meets earning estimates, it'll probably drop since so many investors are expecting too much from First Solar.

It's P/E is above 100 currently, even Google couldn't survive that high.

Shorting this down to the $100/range should provide for easy money.

2008 Feb 22 06:50 PM

[windy city man:]

The article is based on a very sound analysis. The one day $50 upward move can easily be replaced by an equal move downward. Shorting this stock is a good idea but timing is important.

2008 Feb 23 09:44 AM

[locke:]

I love the company but hate the price. Everything is going its way, macro to micro, so it could grow into it's multiple--I wouldn't be short. But I'm sure not buying any shares here.

2008 Feb 23 03:15 PM

[Little Turtle:]

If my memory is good, CSFB has recently written off the books more than $10 Bn. in losses for allegedly sub prime involvement. These guys where unable to forecast the mess hitting their own face, like MOST of Wall Street firms. Please, tell me why you keep talking about the forecasts of these uncompetent liars and manipulators. Remember the Henry Blodget's of the Internet bubble? Here they come again, unfortunately Mr. Spitzer didn't want to find a regulatory model (as opposed to business model) to lock them into an harmless position, just to keep intact his political agenda, so be careful!
Have fun watching this:
docs.google.com/TeamPr...

2008 Feb 23 04:36 PM

[Zachary Sch...:]

Thanks guys for your comments. 115414, you are right in that timing is critical. Even in a bear market, the short side is not easy money. Sharp rallies can destroy profits quickly, but a sharp trader has plenty of opportunity.

Turtle, while I share your opinions of many analysts, it is still helpful to know where they are setting estimates as their writing helps to shape public opinion. I don't want to take anything that anyone gives me at face value, but it is still helpful to gather as many opinions as possible to sift through and round out my own thesis.

Good luck all with your positions (or decision not to have them).
ZDS

2008 Feb 23 05:56 PM

[Zachary Sch...:]

Thanks guys for your comments. 115414, you are right in that timing is critical. Even in a bear market, the short side is not easy money. Sharp rallies can destroy profits quickly, but a sharp trader has plenty of opportunity.

Turtle, while I share your opinions of many analysts, it is still helpful to know where they are setting estimates as their writing helps to shape public opinion. I don't want to take anything that anyone gives me at face value, but it is still helpful to gather as many opinions as possible to sift through and round out my own thesis.

Good luck all with your positions (or decision not to have them).
ZDS

2008 Feb 23 06:01 PM

[Zachary Sch...:]

Thanks guys for your comments. 115414, you are right in that timing is critical. Even in a bear market, the short side is not easy money. Sharp rallies can destroy profits quickly, but a sharp trader has plenty of opportunity.

Turtle, while I share your opinions of many analysts, it is still helpful to know where they are setting estimates as their writing helps to shape public opinion. I don't want to take anything that anyone gives me at face value, but it is still helpful to gather as many opinions as possible to sift through and round out my own thesis.

Good luck all with your positions (or decision not to have them).
ZDS

2008 Feb 23 06:01 PM

[Zachary Sch...:]

Thanks guys for your comments. 115414, you are right in that timing is critical. Even in a bear market, the short side is not easy money. Sharp rallies can destroy profits quickly, but a sharp trader has plenty of opportunity.

Turtle, while I share your opinions of many analysts, it is still helpful to know where they are setting estimates as their writing helps to shape public opinion. I don't want to take anything that anyone gives me at face value, but it is still helpful to gather as many opinions as possible to sift through and round out my own thesis.

Good luck all with your positions (or decision not to have them).
ZDS

2008 Feb 23 06:02 PM

[Zachary Sch...:]

Thanks guys for your comments. 115414, you are right in that timing is critical. Even in a bear market, the short side is not easy money. Sharp rallies can destroy profits quickly, but a sharp trader has plenty of opportunity.

Turtle, while I share your opinions of many analysts, it is still helpful to know where they are setting estimates as their writing helps to shape public opinion. I don't want to take anything that anyone gives me at face value, but it is still helpful to gather as many opinions as possible to sift through and round out my own thesis.

Good luck all with your positions (or decision not to have them).
ZDS

2008 Feb 23 06:02 PM

[Wez:]

Is there a way to short this without having to sell a full 100 shares, other than options? Any short ETFs?

2008 Feb 23 07:53 PM

[pecker:]

I think i will stick tu krispee kreme dolenuts.

2008 Feb 23 10:48 PM

[Zachary Sch...:]

Wez - there should be no problem shorting odd lots of this stock unless the broker that you use requires you to trade in round lots. So the difficulty should not be with the stock but instead with whomever you do your trading with.

2008 Feb 24 09:00 AM

[spf5:]

This article makes a good case, but FSLR reminds me of Xerox in the 60's. Great company and a leader in its field. Untold millions were lost shorting Xerox on the way up...and thousands of investors were afraid to buy due to the high PE.... Put reality aside and buy FSLR...its heading a lot higher.

2008 Feb 24 12:43 PM

[wombatrd:]

If you look at the company the only thing holding sales is production capacity which will be much larger by the 4Q of this year. With oil prices going up the money to be made here is to by FSLR

2008 Feb 24 02:10 PM

[wombatrd:]

Oops! the site posted my comment before I was finished (or proofed). To finish: the money to be made here is to buy FSLR below 180 and set stops at a trailing 5% as it goes up.

2008 Feb 24 02:12 PM

[Camden:]

Zachary, what do yo mean by "short the name in conjunction with a lower multiple stable competitor"? Are you suggesting shorting FSLR and another Solar company? Or, shorting FSLR and buying the stock of a lower multiple stable solar company?

I'd love to know your opinion on which companies constitute a "lower multiple stable competitor." Do they have to be profitable to be "stable"?

FSLR has put forth a long term business plan that will make it VERY difficult for any company to compete in their market. So far they have executed on that plan well above their own projections. So far there is no evidence that there business plan will not succeed. I'd say the wisest long term strategy would be to buy on dips and hold until the business plan cracks. Sure nimble traders MAY be able to get in and out at opportune times, but I think investors will be rewarded by this company that is without peer, has a huge backlog of contracts, is rapidly lowering it's cost of production and is in an industry segment that is still in it's infancy. The solar industry may well be 100X larger than it is today when I have to take money out of my IRA's in 18 years.

2008 Feb 24 07:23 PM

[strumbol01:]

>FSLR has put forth a long term business plan that will make it
>VERY difficult for any company to compete in their market.

I don't think companies based on current silicon wafer or thin film technology will control the market more than perhaps a couple of years. As soon as Nanosolar improves its technology, ramps up production, and go public, it is going to be a "sector killer" and current technologies will go the way of the 8-track tape.

To make the story short, these guys use semiconuctor nanoparticle ink to print the cells on rolls of metal foil. See: www.nanosolar.com/abou...

Disclaimer: I own JASO... but keep an eye on Nanosolar and the market...

2008 Feb 26 06:19 PM

[tessant:]

i really think that first solars run might come to an end...i dont own or short the stock, but companies like nanosolar,etc. will eat into their profits...

-Scott
growthportfolio
"the facebook of investing"

2008 Mar 15 07:05 PM

[ArcticFox:]

This first quarter 2008 is tough quarter to figure, but based on the continued acceleration of the euro beating expectations should be easy. Silicon is still a little costlier than expected according to Sunpower's latest earnings release. Obviously this stock is being manipulated as when the CEO and VP cashed in a cool 60 million. Nanosolar seems to be validited by it's agreement with EDF, but is mum on it's production status and the little 1 MW plant is Germany. Conergy has been mum on both Nanosolar and First Solar, and their own status is uncertain. I would expect FSLR will manuever it's stock price higher in the short term, with the bottom falling out when we least expect it. Shorting just a little.

2008 Apr 28 05:15 PM

[gbp:]

for all you naysayers the stock is now 306 after earnings and I am way long. Come with me on this fun ride and let's get rich.

2008 Apr 30 11:17 AM