As the fall season opened on our calendars, shares of First Solar (NASDAQ:FSLR) seemed to turn brown and curl up along with the tree leaves. In the fourth week of September 2014, the stock price fell off from the low $70s and brushed worryingly close to a line of price support near the $66 price level. To be fair, few stocks were able to keep a fresh, vigorous price that week as nearly every major index from the S&P 500 to the Wilshire 5000 took cuts, some deeper than others. However, FSLR closed down 4.1% for the week and now appears oversold.
What are smart investors and traders to do? Buy into the weakness? Wait for full capitulation to close out short positions?
Earlier this year I had reviewed the company's balance sheet, concluding First Solar management has crafted a strong capitalization strategy and is now investing in projects that can generate returns well above the company's cost of capital. See my article "Sun Shines on First Solar's Balance Sheet" here on Seeking Alpha. Yet, strong financial performance can quickly deteriorate and it makes sense to revisit long-term trends at First Solar.
The company reported $3.53 billion in total sales in the twelve months ending June 2014, providing $376.8 million in net income. The dramatic change in fortunes the company experienced in 2013 has carried over into the current year. Yet various measures of asset efficiency such as return on assets have slipped slightly from the prior year. Return on Assets is now 5.0% compared to 5.9% just six months ago. On its own, this is no reason to abandon First Solar. The measure may have slipped in the near term, but remains well above the solar industry average near 3.3%.
A more valuable signal for investors might come from cash flows. Historically, First Solar has been successful in converting a significant portion of its sales dollar into cash. In the past couple of years, the average cash conversion rate was 24.3%. Unfortunately, in the twelve months ending June 2014, First Solar only managed to turn a dime of each sales dollar into operating cash - a conversion rate of 10.4%. In my view, the recent decline is something to watch carefully.
Analysts are Fair Weather Friends
Near the beginning of the year the kindest rating analysts had been able to muster for FSLR was a Hold rating and most seemed to be leaning toward under-weight. However, guidance from management for strong earnings in 2014, that accompanied First Solar's year-end earnings results announced in March this year, sparked excitement around the shares. Contrarian investors, who took long positions in FSLR at the time of my first article when the stock was priced near $56, would now have a gain near 29% - even after the recent pullback in price.
Management's 2014 guidance does not seem to have been well digested by the analyst community. Analyst ratings for FSLR appear to be largely unchanged since the beginning of the year. The company trounced the consensus estimate for the first quarter, and then missed wildly in the second quarter ending June. When First Solar announced June quarter results, management bravely maintained its prognosis for earnings and cash flow for the year - $2.40 to $2.80 in earnings per share and $200 million to $500 million in operating cash flow. It could be the analyst community has remained aloof because the guidance no longer seems credible. So far in 2014, First Solar has reported only $1.14 in earnings per share and will need to scrape together another $1.26 to reach the lower end of the earnings guidance range.
Cash flow from operations in the first half of 2014, was net cash usage of $199 million. There is a long way to go to report even one dollar of positive cash flow. Granted cash flow from operations in the second quarter by itself was $118 million, decidedly better than the $317 million net cash usage for operations in the first quarter. Yet even the top end of management's guided range for operating cash flow at $500 million is not very impressive given that in 2013, cash flow from operations was $856.1 million.
This walk through the last few months of FSLR trading history helps inform our decision on what trade should come next. The stock price is beginning to look compelling after selling-off. However, our computations of return on assets and conversion of sales to operating cash suggest deterioration in near-term fundamental performance. At the very least the analysis suggests caution is warranted in the near-term.
I believe the stock has yet to find its footing and lower prices are more likely than higher prices - at least in the near-term. Another earnings miss in the September quarter could present a problem for First Solar. After the sell-off in the fourth week of September 2014, the next level of price support appears to be at $64.00. The price level of $58 is also pivotal for FSLR as this is the price near which the stock was trading prior to management's release of its bullish forecast for the year. If management's guidance is lowered or their word loses all believability, a $58 share price for FSLR could be in our future.
Management will need to prove it has resolved the issues that been eating away at asset efficiency and cash flows. The June quarter miss was attributed to project delays. If this is the case, both cash flow conversion and return on assets should improve as those projects finally contribute to sales and earnings. The company has stepped up the scope of its project development, managing entire power plant projects rather than supplying only solar panels. It requires a big step from manufacturing a few solar panels in a factory to handling the many parts of a large sprawling solar complex. I am suspicious First Solar has not yet fully completed the learning curve needed to take this step. It is clear that investment in renewable power generation is expanding and not declining. Thus First Solar is likely to find more not less opportunity. However, strong execution will still be critical.
While it may not be timely to build long positions in FSLR in the near-term, the company still appears to have some strength. Accordingly, it is worthwhile to keep close watch on the stock. It FSLR trades to $64 as I suspect it will, it would be priced at 13.9 times the 2015 earnings estimate. At the $58 price level it would be trading at the bargain basement multiple of 12.6 times forward earnings. Those are very compelling valuation metrics that would give investors plenty of reason to give management time to get the business humming again.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.