Saturday, June 4, 2011

I Bought Some First Solar (FSLR) Today! Part 2

This is going to be a reoccurring theme...buying First Solar on the cheap.  As I try to stick to my stock allocation strategy, I can't help but keep wanting to buy more of First Solar.  This stock is now 33% off from its 52-week high of $175.  If you buy now and it rises back up to that point, you get a nice 48% gain.  So, I decided to buy more today.

Why am I so confident in the stock?  Here's why.  First Solar reported its Q1 earnings on May 3, 2011.  That is more than 4 months into the FY11.  It reiterated its earnings per share guidance for the year of $9.25 to $9.75.  First Solar has a pretty good record for beating analyst estimates, which don't deviate too much from the issued guidance.  So, chances are First Solar will earn at least $9.25/share.  At $118, this works out to be a forward P/E of 12.8, which is a very, very modest P/E ratio, considering it has been sitting near 20 for the past couple of years.

What if they miss estimates?  How bad could they be?  Let's say they miss by a full $1.25.  That gives $8.00/share, which results in a P/E of 14.75, still below the current P/E of 17.  I would say there's quite a bit of margin of safety here.  Since the year is back-end loaded, I can somewhat foresee that the stock price will rise in the second half as Q2 and Q3 results are announced.

Moreover, I believe First Solar may actually beat the estimates.  It earned $1.33/share in Q1, which beat estimates by $0.17/share.  That is not really the important part.  The important part is that they achieved this despite some difficulty.  Their CFO, Mark Widmar, explained in the Q1 earnings call that "net sales for the first quarter were $567.3 million, down $42.5 million or 7% compared to the fourth quarter of 2010. The decrease was primarily driven by lower volumes as we allocated modules to system builds to meet contracted delivery schedules. Revenue recognition is expected for those volumes later in the year."  What this means is that they had produced a number of panels, but they went to the system builds (large scale projects), where the customer doesn't pay until a certain milestone is achieved in the project.  The product is out the door; they're simply waiting for the money to come rolling in.

First Solar also benefits from the fact that they are a systems builder.  So, instead of just selling panels, they actually build solar farms using their own panels and sell the farms to operators.  An analogy that can be used is this.  There are 2 miners who operate gold mines.  Miner A mines the gold and simply sell the gold bars at whatever price gold happens to be.  He makes money, but margins are low.  Miner B also mines gold, but he also has a jewellery wholesale operation.  He signs contracts with Tiffany and the like at the beginning of the year and produces fine gold jewellery for them using the gold they have mined.  Miner B is at an advantage because he is no longer selling a commodity.  You can't go on the open market and buy a designer necklace at the current necklace price.  There is no current necklace price for a designer necklace.  Miner B is able to differentiate itself from competitors.  He also has good visibility of what's coming down the pipeline.  He already knows what the contracts call for and the prices at which the goods are sold.  Therefore, First Solar's forecast carries more weight than pure panel makers.  Pure panel makers make forecasts based on how many panels they can produce and a guess of what the average selling price (ASP) would be.  If the ASP falls dramatically over the course of the year, the forecast would no longer be correct.

That said, First Solar is likely not immune to falling ASPs.  If customers see a dramatic drop in ASPs, they may want to re-negotiate the price of the system.  Customers typically aren't stupid either.  This risk, however, is smaller than the risks that pure panel makers face.

Am I nervous about the dramatic decline in stock value of First Solar?  Sure!  Am I hopeful that it'll bounce back?  Absolutely!  In the game of stocks, we need to take out emotions, which often drive us to do irrational things.  Let's try to keep our heads clear.  In 12 months time, when First Solar is trading at $200, we would likely ask ourselves, why didn't we buy more when the stock was at $120?