While many gear up for the elections and the Federal Reserve, I am bracing myself for a barrage of earnings from solar companies. Thursday night, First Solar (FSLR) kicked off the earnings parade in disappointing fashion as the market reacted by taking the stock down 9%. It seems that the market agonized over two main issues: declining margins and slowing business in Germany. The good news is that both of these items are old news and largely anticipated, suggesting the market over-reacted. The bad news is that after all this time correcting telegraphing trends and outlining risks, FSLR still cannot shake these persistent issues, suggesting that overhang remains thick for the stock.
My commentary references three primary sources: the third quarter earnings release, the presentation for the conference call, and the Seeking Alpha transcript for the call. I am covering the items that are of most interest and importance to me, and my comments do not represent a complete description of FSLR’s presentation.
The best news of the day was FSLR’s increase in guidance for 2010, especially on earnings:
- Net sales of $2.58 to $2.61 billion, increased from the previous guidance range of $2.5 to 2.6 billion.
- Earnings per fully diluted share of $7.50 to $7.65, increased from the previous guidance range of $7.00 to $7.40.
First Solar will announce 2011 guidance on December 14.
Revenue growth for the quarter was strong as expected. The $797.9M in net sales was a healthy 66% jump from 2009’s third quarter and up 36% form the previous quarter. Net income per fully diluted share increased 14% year-over-year and 11% from the previous quarter to $2.04. Cash and cash equivalents declined slightly to $621M from the end of 2009. Marketable securities and investments almost doubled to $212M. FSLR’s cash and marketable securities are now combined for an impressive $997M (still off from the peak of $1.1B in Q409), contributing to a total current asset bulge of $1.6B. Total liabilities are $900M including $224M in long-term debt and no short-term debt (current portion of long-term debt equals $26M).
Gross margin fell to 40.3% for the quarter. The lowest level in five quarters. FSLR experienced a small hiccup in its downward pressure on module cost per watt. An extra penny per watt was added from process changes that decreased yield and equipment uptime. During Q&A, President Bruce Sohn reassured analysts that FSLR has not diverged from its long-term cost-per-watt roadmap. Volatility in currency exchange – FSLR is now hedged against the euro 77% on sales, 92% on net income – and a change in product mix added to the pressure on margins. Overall operating income percentage fell to 26.5%. Over the past two years, only Q409 was lower at 22.6%. On the other hand, the $2.04 in diluted EPS is the highest in 6 quarters. First Solar will need the current trend to push higher to keep pace with its relatively high valuation (for solar) of 16 forward P/E, not to mention a price-to-sales ratio of 5.0 and price-to-book ratio of 3.9.
First Solar characterized the projected decline in German solar demand as a diversification in overall demand, a healthy development for solar. After increasing for four consecutive years, the German market will finally decline next year. FSLR combined the projections of numerous analysts to estimate that the overall solar market will grow 11% to 15GW and grow another 15% to 17.2GW in 2012. North America, China, and the “rest of world” (ROW) will experience the fastest growth. This growth means that FSLR’s overall opportunity remains healthy, notwithstanding potential hiccups from escalating trade disputes with China). FSLR estimates that its German business will decline faster than market to a ~28% share while its business in the rest of Europe and North America will expand dramatically to ~67% of business. Germany was 77% of FSLR’s net sales in last year’s third quarter. The surge of business in 2010 to 7-7.2GW has occurred ahead of changes in Germany’s feed-in-tariff (FIT). So, it is no surprise that this demand will fall to 4-5GW next year.
First Solar cited the following risk factors for Europe:
“There is a potential for a softer market in Germany in 2011 as the industry adjusts to the lower feed-in tariff and there is a possibility of further government action at the EEG [Germany’s Renewable Energy Act] and power grid is under review in 2011…France and Spain FIT reviews could impact 2011 economics and market opportunity.”
The company is mitigating risks by diversifying across Europe and expanding in North America: price adjustments in Europe and incentives for partners to “…diversify across Europe and other transition markets”; nurture a 2GW pipleine of business in its North American pipeline; and leveraging dynamics in North America with “…renewable portfolio standards, the ITC in cash grant, DOE loan guarantees and attractive ROE economics…and working with the industry to promote extension of the ITC cash grant and DOE loan program beyond expiration to support project economics.”
First Solar is rapidly expanding production capacity to meet its market opportunity. After holding capacity growth to 16% in 2010, the company is essentially sold out for the rest of the year. FSLR will expand 92% to 2.7GW by 2012. Such an acceleration no doubt has some worried about the company’s exposure in case bullish demand expectations fail to materialize (or sustain). Based on prior history, I am assuming FSLR’s management is on target here. For example, FSLR indicated that demand is strong for 2011 and “well contracted” with most of pricing in place.
As usual, First Solar management is keenly focused on the long-term health of the business. As an example, CEO Robert Gillette explains during Q&A that the company is not worried about short-term or week-to-week pricing competition:
“…our strategy is still driven relative to pricing by our mission, and that really is to make sure that we’ll enable our customers to develop these applications around the world. The shorter cycle would be Germany at eight to 12 kind of months. And as you move out of Germany, it can take as long as 48 months or more depending on where you’re doing it. So really, we don’t pay attention to the near-term or week-to-week type of pricing. All of our focus is to drive the LCOE down and get to a point where we can compete with these traditional sources especially on the peak inside.”
So, at this point, I call First Solar the “elder statesman” amongst solar companies (I will be looking for nicknames for all the companies I examine on a regular basis). Management is great at long-term planning and execution, and the company is extremely transparent regarding the direction and risks of its business. There is no reason to expect much flash or tremendous upside surprises, just consistent progress along the company’s growth strategy from existing to transition to sustainable markets (first presented in July, 2009). Bumps will appear in the road and they will generally provide buying opportunities. I think Friday’s negative reaction is one of those opportunities.
As I did last quarter, I cleared out my longs ahead of FSLR’s earnings. This time it meant closing out a call spread that I bought to play a run to and through $150 – I was hoping for a break above resistance ahead of earnings. The risk/reward for playing FSLR earnings looked poor to me, especially with options. The best post-earnings return was 83% on the Nov 145 put, but a trader would have had to risk $520 to get it (before Thursday’s close). Of course, the market obliterated the flyer on an out-of-the-money call. Straddles lost significant amounts of money from a collapse in implied volatility even with the 9% drop in the stock.
I continue to maintain my bullish stance on FSLR and look to dips in FSLR for buying opportunities. I bought my first tranche of shares late in after-market trading, looking for FSLR to hold support at the 50-day moving average (DMA). The stock closed post-earnings trading on Friday just below that support, and it is clinging to the October lows. Next support is around $126 at the 200DMA.
Given 2011 guidance is not coming until mid-December, I am highly doubtful FSLR will re-challenge its 52-week highs anytime soon (not to mention the overall stock market remains dangerously overbought). That guidance will be a key catalyst. For now, I am expecting FSLR will not beat this longer-term resistance between $150 and $160 until the first half of 2011.
*All charts created using TeleChart:
Be careful out there!
Full disclosure: long FSLR