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FSLR Q2 Earnings July 29, 2010; Option Trade Candidate?

|Includes: First Solar, Inc. (FSLR)

FSLR is set to report Q2 earnings on July 29, 2010.

Revenue Consensus: $541.15M
EPS: $1.60

Folks, FSLR is a tough cookie when it comes to earnings play. I have seen it many times, when FSLR beats on revenues and the EPS number by 5-10 %, but the stock gets hammered after hours. 

Look at Q4, 2009:

Revenues were $641m vs $580m (estimate)  -  that's a monster beat (10%+)
EPS was:  $1.65 vs $1.52 (estimate) - 9% beat (it's so-so)

Result: Stock went down from $126 to $116;

The Reason: LOW GROSS MARGIN!!! 

Gross Margin was 41% vs 51% just a quarter ago due to rise in EPC (low margin) product development business.


FSLR Margins:

1.EPC (Engineering, Procurement and Construction) business has 5-6% gross margin.

2. Module business has 49-52% gross margin.

Q4 2009 had a rise in EPC business which brought down the margins from 50% to 41% in just a quarter.


Now let's look at Q1, 2010
FSLR reported $568m  vs $548m (estimate) -> OK beat...
EPS $2.00 vs $1.64 (estimate) -> Now we're talking!

GROSS MARGIN: 49.7% + Raising Guidance! -> the next day FSLR closed $22 higher to $150.



What will happen on July 29, 2010 when FSLR reports Q2:

Let's look at bearish and bullish facts and assumptions:

BEARISH POINTS:
1. Lower margins for Q2, Q3, Q4: - Higher Sales, Less Profits:
Company guided in Q1 conference call: 41-43% margin for the 2010. The thing is if you got 49.7% for the Q1, it will take 3 quarters just below 40% to make the numbers meet the guidance, which means we will see lower margins in next 3 quarters.

2. Weak Euro in Q2
As more than half of the revenues come from Europe, weak euro will have a negative effect on the revenues and the earnings. The company has positioned for $1.30 / euro, but euro got as low as $1.19.

3. Germany Incentives:
Germany is the biggest market for First Solar, and since Germany is about to cut the subsidies, there will be uncertainty going forward. This is definitely a negative sign and I would take it very seriously.

4. European Crisis: - Uncertainty
It is no secret that Europe is in bad shape, and hence solar market is highly subsidized in Europe, the subsidies may come to an end, as the Governments are trying to cut the spending budgets all across the board. Spain, Italy, Germany have already announced serious budget cuts.



BULLISH POINTS:

1. Strong Demand = Higher sales. I would not be surprised to see FSLR to hit $600 mil in Q2 revenues.  

2. Higher Margins  - it's possible that their EPC business was a very small pie of the Q2 revenues and thus will not have a devastating negative effect on the gross margins. I think if FSLR does better than 47% on margins this quarter, the stock will most probably go higher. On the conference call, they guided that EPC business will have negative impact on the Q2 margins (slightly)...so I guess we will wait and see.

3. Increase Guidance: - FSLR may increase the guidance and confidence going forward based on the growing demand outside of Europe.


Final Assumption and The Trade:
I think that the stock may sell off after the earnings report.  I cannot justify 18 P/E when the earnings are set to grow by 10% with so much uncertainty going forward.

I will take the bearish case here.

The Trade: Bear Put Spread (Debit transaction)

BUY to OPEN $140 August put for $7.70
SELL to OPEN $135 August put for $5.50
Net Debit $2.20
 
Max Profit: $2.80 on the spread or 130% return, If the stock trades below $135 by the August expiration. I would exit the trade earlier maybe fetching 80% return...

Max Loss: $2.20 if the stock trades higher than $140 by the OE.

BEP: $137.80  by the OE in August.

I would wait to make the trade on the day of the earnings before the close, as I could get into that trade for a better price if the rally continues.

Well, good luck to you all! Do your own due diligence prior to placing your bets. 

You can see some of my trades on my blog at :  optiontrader13.blogspot.com




Disclosure: None