Why investors shouldn’t panic over First Solar’s stock drop - Bob Ciura
To say that this has been a difficult year for solar industry heavyweight First Solar (Nasdaq: FSLR) would be an understatement. The persistence of low oil and gas prices has incentivized greater consumption of fossil fuels, which has put a dent into demand for solar power. In addition, solar more broadly has suffered from a flood of cheap supply, which resulted in margin pressure throughout the year.
Reflecting the challenging conditions facing the solar business, First Solar stock is down 40 percent so far this year. For context, the S&P 500 Index is up 6 percent year-to-date. It goes without saying that First Solar has under-performed, but forward-looking investors should not abandon ship just yet. While the near-term may continue to be volatile, as the company works through the industry headwinds, the long-term outlook remains positive.
The picture dims for First Solar in 2016
First Solar had a lot of momentum heading into the year. It set a company record last year with $3.6 billion in net sales. It grew revenue by 5.5 percent for the year, and importantly, established that its business model can be consistently profitable. First Solar earned $546 million in net profit last year, which was up 38 percent from the year before. First Solar’s growth and profitability were due to strong bookings and the benefits of its high-margin product portfolio.
In addition, First Solar is a well-run company. Its management team largely resisted the mergers and acquisitions trend that swept through the solar industry in recent years. While many other solar companies borrowed heavily to acquire smaller competitors, this backfired when some solar companies took on more debt than they could repay. Consider SunEdison’s April Chapter 11 bankruptcy filing as a prime example. Fortunately, First Solar did not engage in fruitless M&A. Instead, it focused on increasing efficiency and building a sustainable, profitable business model.
As a result, the company has a strong balance sheet. It has $1.7 billion in cash, cash equivalents, and marketable securities, and just $161 million in long-term debt. The company carries a net cash position of $1.4 billion, which comprises 35 percent of its current market capitalization. This means the company could in theory pay off all of its debt and buy back 35 percent of its stock. Or, it could use this cash to invest in research and development, to go after future growth opportunities.
The reason why the stock has performed poorly despite all of these positive developments is that the company cut its outlook for the full year after reporting its second-quarter results. For 2016, First Solar expects $3.78 per share in profit at the midpoint of its forecast, down from prior guidance of $4.30 per share. This is indeed a significant reduction. Earnings are expected to come in 12 percent below previous forecasts. First Solar has attributed this to higher operating expenses.
Investors appear greatly concerned over whether First Solar’s impressive growth in recent years is sustainable. As the solar industry increases its penetration, costs are coming down, which has enhanced profitability. But this has also caused competition to intensify, including from international markets like China, which is flooding the U.S. market with cheap supply. There is a significant fear that First Solar’s future projects will carry much lower margins going forward. The market is taking First Solar’s full-year earnings guidance reduction as a sign of things to come.
There is a rise in uncertainty, which is never good for publicly-traded companies. Analysts are beginning to question whether future projects will be utility-scale, or if the scale of future projects will compress. Analysts are getting more bearish on First Solar stock, which has added to the negative sentiment under-pinning the sell-off. Analysts at Mizuho and Barclays (NYSE: BCS) both cut their price targets for First Solar stock in the past week. Mizuho reduced its price target from $67 to $46, while Barclays cut its outlook from $68 to $50.
Still, it is important to note that analysts are still bullish on First Solar stock overall. First Solar currently trades at $39, which means Mizuho and Barclays still expect 18 percent and 28 percent upside, respectively. Investors should stick with First Solar because even though growth may slow going forward, it is still highly profitable and is expected to continue growing, albeit possibly at lower rates. First Solar stock could be a buying opportunity if its earnings do not decline further from its current guidance range.
Companies to watch
SunPower (Nasdaq: SPWR): SunPower’s latest earnings report is also contributing to the sell-off in solar stocks over the past two weeks. The stock fell 30 percent in a single day when it cut its own outlook for the remainder of the year. SunPower now expects to lose $175 million this year, which is a huge reversal because the company told investors in May that it expected to earn a $50 million profit in 2016. SunPower is the second-biggest solar panel producer in the U.S., so it is no surprise that a return to losses has sent shockwaves through the solar industry.
JA Solar (Nasdaq: JASO): Investors should be on close watch for JA Solar’s upcoming second-quarter earnings report, scheduled for Aug. 17. Analysts will be scrutinizing JA Solar’s earnings for any guidance the company has to share regarding 2016 full-year results. If management follows suit with the broader industry and cuts guidance, the stock may see a significant sell-off similar to industry peers First Solar and SunPower.
SolarCity (Nasdaq: SCTY): SolarCity has had problems of its own maintaining profitability—it lost $56 million last year—but it is nevertheless a rare example of a solar stock that has performed well this year. It has bucked the near-term challenges facing the industry thanks to the recent acquisition offer made by Tesla Motors (Nasdaq: TSLA).
Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.