If you're investing in an industry with a range of headwinds, then it pays to stick with the company that offers the strongest track record, lowest costs and most visible long-term backlog. That's been my logic in support of First Solar (Nasdaq: FSLR), which is the "best house in a bad neighborhood," as I wrote when I recommended the stock in mid-July.
Back then, I assumed shares had hit bottom after a prolonged sell-off. Boy, was I wrong. Shares have continued tanking in sympathy with the entire solar sector. A $10 billion in reduction in the company's market value in the past year has surely been sobering. This company may be the "best house," but it's the "bad neighborhood" that really matters right now.
Why the steady drubbing? In recent weeks, prices for solar panels have been plunging, in large part due to Germany's decision to wrap up its heavy slate of solar spending immediately, rather than a quarter or two from now.
The timing for First Solar is abysmal. After cutting its manufacturing costs by 30% in the past three years, the company says it is just 19% away from being truly competitive with more traditional electricity sources such as coal and gas-fired power plants -- without subsidies. Thanks to more than $100 million in annual research and development spending, First Solar should get there in a year or two. In effect, the stage is set for solar power, led by First Solar, to really take off in a few years -- without the need for any sort of government support.
But right now, investors keep dumping all solar stocks. (First Solar hit a four-year low on Wednesday morning, Oct. 12, before a subsequent rebound.) The recent pressure, on top of bad news out of Germany and Solyndra, is also attributable to a realization that First Solar's near-term quarterly results could come in below current forecasts. Management has bluntly stated First Solar will lower its prices to protect market share as Chinese rivals flood the market with lower-cost solar panels. That's a wise long-term move, but will likely deliver a tough headline when quarterly results are released on Oct. 28.
The challenge for investors is determining when to pivot from the near-term depressed outlook to the still-bright long-term roadmap. After all, shares already appear quite depressed at about six times projected 2011 forecasts. Even if analysts lower their current 2011 earnings per share (EPS) outlook from a current $9 a share to about $8, this stock is still too cheap. Analysts at Auriga figure shares "offer compelling value even if we were to cut our earnings, or earnings multiple, or both by as much as 20%." They recently lowered their price target from $154 to $120, which is still more than double the current price.
Ah yes, those analyst price targets. Wall Street has proven far too optimistic in establishing price targets for First Solar. Indeed, many analysts have been steadily taking down their targets from $150 to $130 to $110 to $90, where many of them now stand. In effect, they've got no credibility, and current price targets ring hollow.
But it's also clear shares of First Solar have fallen far below any sort of intrinsic value. This value lies in steps taken in the past few years, when First Solar took it on itself to create demand for its technology by developing its own massive energy programs. The company recently sold its 550 MW project, known as Desert Sunlight, to GE (NYSE: GE) for an undisclosed amount. A consortium run by PG&E (NYSE: PCG) and Edison International (NYSE: EIX) has agreed to buy the energy output of the complex. In addition, Exelon (NYSE: EXC) will buy First Solar's 230 MW Antelope Valley project. First Solar gets to supply these projects with all of the necessary gear and no longer carries the same level of balance sheet risk.
These long-term deals explain why First Solar are expected to keep earning close to $10 a share for at least the next three to four years. I assumed this kind of visibility into long-term backlog would support the stock. I was wrong. A perfect storm has crushed this stock, and it won't strongly rebound at least until earnings are out later this month and management issues revised forecasts. For that matter, shares may not stage a rebound until 2012, when the industry finally finds a floor in terms of pricing and demand. Yet the chance to own an industry leader at such a low valuation remains compelling.
Risks to Consider: Industry analysts say solar panel pricing will hit bottom in coming quarters as recent capacity additions are brought online. Yet the entire solar sector won't sustain a rally until proof of a bottom has emerged.
Action to Take --> If you've been unfortunate enough to own First Solar on the way down, then this is a lousy time to be a seller of the stock. But it could be near time to average your cost basis down by buying more shares -- but only if you're prepared to wait. If you don't yet own this stock, then the current selloff creates a very compelling entry point. Shares could still weaken further -- possibly into the $40s, but at this point the long-term upside significantly outweighs the long-term downside.