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Last week investors were treated to yet another earnings announcement from First Solar Inc. (FSLR) stating that the company is growing sales at a tremendous rate and that profits reached a new record. Management wowed analysts by stating that new production capacity would come online sooner than expected thus having a positive impact on next years number of megawatts produced. The number of customers doubled over the last year with a grand total of 12 clients, with long-term contracts now stretching out into 2012 representing over 3 gigawatts of production.  On the surface everything looks splendid.

As might have been expected, traders celebrated the news by pushing the stock higher - adding over 50 points in a single day. Very few want to sell stock in a company that is growing sales at 281% year over year and increasing production at such a solid clip. The news is likely to continue to be good as management stated that the three additional plants in Malaysia are on schedule to be completed according to previous guidance with all plants online by the fourth quarter of 2009.  The result will be an annual production rate of roughly 1 gigawatt once all facilities come online.

Despite all the good news embedded in the announcement, and the analysts who trumpeted another business success, there appears to be a few items of concern when digging deeper into the details.  First of all, the company noted that this quarter represents a steady state quarter with the full benefit of capacity online with no ramp up costs.  This is a sophisticated way of saying that everything was operating as good as it gets.  In the future, ramp up costs will likely bite into profits making last quarters feat harder to duplicate.   A second issue is that the company has benefited significantly from a rise in the Euro last year.  While this is not atypical of many international companies, I was surprised to note that a very large portion of the revenue increase was due more to currency issues than actual higher sales.  While still impressive, this fact takes some of the hit out of the blowout revenue numbers.

Management spent some time on the conference call outlining their future focus on Return on Net Assets (RONA) as a primary metric, replacing their previous focus on operating margins.  There is nothing inherently wrong with this issue except for the fact that it doesn’t take too much thinking to realize that the future margins will be squeezed as pricing for the end products will likely drop more quickly than the efficiency gains the company is seeking in the production process.  It is wise for management to prepare the investor base for this fact, but as margins become compressed during the course of 2008, the likelihood of the stock multiple declining is very great.

The company has a very concentrated presence in Germany where subsidies have driven strong demand for solar products.  First Solar understands that it needs to branch out into new markets if it will survive in an increasingly competitive market.  While goals have been set to deliver products to markets with little or no subsidies driving demand, the words must be backed up by action in order to gain credibility.  If selling to free markets becomes a more difficult process than previously expected, the exponential ramp in production capacity could end up being a huge gamble lost with large capital investments sitting idly by.

The most difficult issue to consider when investing in FSLR is the enormous multiple on the stock right now.  Even considering CSFB’s optimistic estimate for earnings of $8.75 in 2010 (that’s right - they have estimates that far out), the stock still trades at a 24 multiple to these three year projections which assumes 83% compound annual growth of earnings.  These are staggering numbers and looking back in history, there are very few times when such overarching investor optimism turns out to be a wise buy.  The deck seems stacked against shareholders at this time, not due to the inadequacy of management or the strength of the company, but simply due to the unbridled enthusiasm of investors.  The greed of Wall Street is a powerful force and there are no guarantees that this force will not push the stock higher in the short run.  However, the wise long-term strategy appears to be to wait for a better entry point at a lower price, or to potentially short the name in conjunction with a lower multiple stable competitor.

FSLR Notes

FD: Author does not have a position in FSLR

Additional Reading:

Marketwatch details the quarterly release

ZachStocks covers competitor LDK Solar

Trader Mark wit a piece on competitor Suntech Power

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