Since reporting earnings August, 1, First Solar (FSLR) has been on a tear. The stock has bounced off its 50-day moving average (DMA) to gain 45%. On the first post-earnings day, FSLR gained as much as 29% before pulling back to a 21% gain. On the next day, the stock lost 5%, and it looked like FSLR was on its way to a post-rally fade so common with solar stocks (for example, see "First Solar and SunPower Confirm Bearish Patterns" from February, 2012).
The ability of FSLR to overcome this tendency to fade has turned into very bullish momentum for the stock. This trading action represents strong follow-through to the nascent bullish action I pointed out on June 19th:
Assuming the rally [in the S&P 500] continues, this should be a time where beaten up stocks get fresh bids for swift rallies. The market is full of disaster zones right now and many, many candidates exist. No surprise, one of my favorites is First Solar . I will write more about this stock and company at another time (archives here). Until then, note that the chart shows FSLR bouncing off all-time lows with strong buying volume. For the first time since the beginning of the year, FSLR has actually maintained some upward momentum and sellers were unable to fade the sharp, 20%+ bounce from last week. In other words, FSLR could very well be at the beginning of a violent short squeeze. Solar stocks as a group should be closely watched here.
First Solar's bounce from the June lows continues in impressive fashion
Shares short against First Solar reached an all-time high just ahead of earnings at 29.27M shares (58.3% of the float). This extreme bearishness must have contributed to the violence in the post-earnings surge as First Solar posted strong headline results.
After sharply dipping in the first two months of 2012, shorts have ramped strongly against First Solar
Source: NASDAQ short interest
Despite the encouraging action in First Solar, I think it is still a trading stock for now. Accordingly, I used the rally to close out near-term call options and switched to near-term puts to hedge the remainder of my (base) position in FSLR. I next looked deeper into the earnings results to try to identify whether something sustained and lasting had changed in First Solar's business. In "First Solar: Q2 Results Show Its Financial Strength And Market Potential Are Unmatched," Helix Investment Management writes one of the more eloquently bullish (and encouraging) pieces on First Solar's longer-term prospects that I have read in a long time. I refer readers to this analysis for a bullish spin on the earnings results (or read the transcripts for yourself on Seeking Alpha).
Helix refers to respected solar analysts at Maxim Group in noting how massive debt burdens at Chinese solar companies threaten more bankruptcies in the industry. FSLR's stronger balance sheet presumably puts the company at a competitive advantage. However, Helix did not refer to Maxim's bearish spin on FSLR's earnings. Aaron Chew of Maxim Group recently wrote a SECOND bearish piece to emphasize the one released right after earnings. Chew made the following skeptical observations right after FSLR's earnings report (reprinted with permission):
While FSLR jumped 19% post-market following 2Q12 upside and higher 2012 guidance, this belies underlying deterioration, in our view. Revenue and EPS x-1x items sailed past the Street on the AVSR milestone payment, but organic margins and opex were masked by a stock comp reversal of ~$40m or $0.45 in EPS. FSLR may have raised EPS guidance $0.20 to ~$4.45, but net of this 1x gain and a $9m depreciation benefit from the writedown, we estimate EPS was actually lowered by $0.50. While the positive headline may buoy the stock near-term, we expect gains to be brief as the core deterioration comes to light.
Chew maintained his sell rating and an amazingly low $9 price target.
With the stock continuing its strong rally, Chew underlined his bearish read on FSLR earnings on Friday, August 10th. His language was even stronger this time around:
FSLR's stock has jumped 47% (vs. 2% for the S&P 500) since earnings, likely due to lopsided sentiment and a misinterpretation that its LT outlook is bolstered by (1) the first guidance hike in years and (2) the new Campo Verde project. While the stock seems cheap at ~5x 2012E-2014E EPS, this is inflated by 1x contracts priced at higher 2009 levels. Organically, FSLR's advantage vs. the Chinese has evaporated; even with new projects, unsubsidized solar system ASPs of ~$1.50 yield normalized EPS of <$1.00, and a DCF of contracted cash flows (less liabilities) suggest a stock worth no more than $9.
Chew goes on to call FSLR "fool's gold" and labels the low P/E as "a mirage" given downside risks to module pricing and margins:
With third-party module sales now unprofitable, EPS power swings entirely on its project business, which we expect to benefit in 2012 to 2014 from projects with PPA contracts signed at higher levels when natural gas prices were elevated and benefit from a 30% cash grant. While these projects could generate ~25% gross margin, today's ASPs point to 15%-20%…
…at our estimate for unsubsidized solar pricing of ~$1.50/W-to achieve $0.10-$0.12/kWh in markets with >1,200 sun hours-even a module cost/W of $0.50/W and total BoS of $0.80/W point to normalized gross margins of only 10%-15%. At a 1.8 GW and $250m opex run rate, this implies EPS of ~$1.00…
…We believe delays and budget overruns pose more downside risk than upside.
I was surprised by the additional emphasis on the bearish case with this second research piece. After all, Chew was a reliable bull on the First Solar story when times were much better. Regardless, I continue to hold high regard for his work, especially given his ability to recognize the changing tides in the solar industry and remain appropriately flexible in his analysis. So while the $9 price target does not dissuade me from holding a baseline bullish position, it does make me more aggressive in hedging that position.
The chart above shows that FSLR has finally a stalled a bit over the last three days. If these levels do not mark the peak of the recent rally, I then expect a top around $24 where the initial surge after FSLR's restructuring news ended. On the downside, I am looking for FSLR to eventually fill its post-earnings gap up but find some temporary support at the now upward trending 50DMA. At that time, I will evaluate whether it makes sense to flip the trade back to a (short-term) bullish bias. My assessment will depend on whether short interest has increased to even higher levels, and whether the general stock market still maintains a bullish bias.
In the meantime, Chew's $9 price target will certainly not get realized in a straight line from current levels. As a trading stock, FSLR will gyrate mainly on whims and the latest sentiment. Both forces could be enough to prevent FSLR from dropping all the way to $9 before some more sustained positive catalysts appear. Time will tell as always. Along the way, I continue to expect some great trading setups for bulls and bears.
Be careful out there!
Disclosure: I am short FSLR.
Additional disclosure: I am short FSLR with near-term put options. I also hold calls and am short some long-dated puts.