First Solar (FSLR, Financial) is quietly becoming a hedge fund favorite. Cliff Asness’s AQR Capital Management and John Overdeck’s Two Sigma Advisors have recently upped their positions to $137.5 million and $63.3 million worth of FSLR shares respectively.
These hedge fund buys are coming even as higher profile solar stocks like Elon Musk’s SolarCity (SCTY, Financial) and Ascent Solar (ASTI, Financial) grab headlines for all the wrong reasons. While delistings and debt woes plague those solar companies, First Solar is flying higher on a strong quarter and proving the hedge fund buyers right to double down.
The earnings highlights: Revenue fell about 6% year over year to $942.3 million, actually above expectations of a 7.1% decline. EPS was also a huge beat, with $1.60 more than doubling expectations thanks in large part to cost cutting. Selling, general, and administrative expenses — often a catch-all that covers up a lot of corporate bloat — fell an impressive 11% on a year-over-year basis, while free cash flow rose to $838 million. This puts the company in a strong financial position to focus on growing sales.
It will need the focus. Solar as a sector is struggling against cheaper oil, which is making it a less compelling investment for homeowners and businesses alike. As represented by the Guggenheim Solar ETF (TAN), the sector is down about 47% since August 2014, when oil began to fall. The ETF has more severely underperformed recently as oil continued its slide, and is down 43% in the past year. Several companies — First Solar included — are cutting sales forecasts for 2016, a tacit admission that cheap oil is making them less competitive.
A closer look at the details of First Solar’s last quarter shows surprising underlying strength against the backdrop of cheap oil. As CEO James Alton Hughes highlighted in the company’s earnings call, bookings worldwide are up and getting stronger in the U.S. — where recent investor sentiment would suggest capital expenditure is falling. However, Hughes noted, "We will see a larger contribution from the U.S. versus what we would've thought, let's say, 9 months to 12 months ago, as a result of the ITC extension and the firming of demand.” In other words, companies want to buy more solar panels, not less.
Thanks in part to the U.S., module shipments are rising from 3.7 gigawatts by the end of December to 4.4 gigawatts by the end of February:
Due in part to this and in part to weakening competition, Hughes is targeting a 20.3 gigawatt market globally, of which North America is almost half:
First Solar also sees a 48% year-over-year increase in potential gigawatt bookings at the end of 2015, with a similar growth rate expected into the foreseeable future.
Valuing First Solar’s future growth
Assuming First Solar can continue to grow its market share as the market itself continues to grow while also cutting costs, how much can we value First Solar’s future growth?
When we see First Solar’s revenue and EPS growth rates, we see an even year-over-year change due in part to the seasonality of the industry. Beyond that lumpiness there is no sign of a slowdown in sales or earnings growth, with trailing-12 month revenue and earnings growth both exceeding 100%:
Projecting a smooth decline in growth from that doubling to about 15% growth in five years' time — an excessively modest estimate — we can project revenues in five years at $16 billion and EPS of $28.45. Since solar power spending eclipsed $175 billion in 2014 and solar capacity grew 17% in 2015, getting to $16 billion seems pretty easy for First Solar. If it does, valuing the company at three times sales (a very modest valuation for a solar company), we get a stock price above $106, or 67% above its current level.
Even assuming similarly modest growth in EPS as sales grow and a P/E valuation of 17 times trailing-12 month EPS, we get a price target of $89.93 — and that’s a valuation below the S&P 500’s current level. Still, such modest assumptions get us a 41.4% upside from First Solar’s current stock price.
It’s no wonder hedge funds like First Solar. With its strong growth rate, low current valuation and prudent cost cutting, it is looking like a perfect combination of growth and value at a reasonable cost. While falling oil prices might hurt the stock and the solar industry a bit more in the short term, if its current trajectory holds, tremendous upside is bound to come in the next five years.
Disclosure: I have no position in FSLR or any solar stock, and no intention to buy or sell FSLR or any solar stock in the forseeable future.
