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Solar Losers: 4 Keys to the First Solar Selloff

First Solar sells off after beating and raising, triggering fears that the solar sector is due for another downturn.

(First Solar earnings story updated for Jinko Solar earnings)



) -- The reaction to

First Solar


earnings might have seemed like a big one, with shares of the U.S. solar bellwether ending down 9% on Friday. Yet the jury is still out on whether the First Solar earnings are a sign of worse to come -- for it or for the whole solar sector -- or a one-time smattering of negative earnings details that won't slow down the solar company, or sector, from ultimately pushing its shares higher.

On Monday morning, Chinese solar company

Jinko Solar


blew past expectations of 96 cents earnings, reporting $1.75 per share on revenue of $215 million. The Street had expected earnings of 96 cents per share on revenue of $153 million from Jinko Solar. Its shares were up 15% in the pre-market on Monday.

Jinko Solar also raised its fourth-quarter and full-year guidance, with fourth-quarter revenue at $210 million to $220 million, and the full year revenue peg at $638 million to $648 million. The full-year raise was an increase of more than $100 million from previous guidance, and the Street consensus had been $529 million.

The Jinko Solar earnings pose the question: Will the Chinese solar stocks once again move in a direction distinct from First Solar on beat-and-raise quarters? For one, First Solar selling off on a beat-and-raise quarter is not a rare event. In fact, it happened last quarter. First Solar shares declined by 9% after its last quarterly results, almost exactly in line with the market reaction to the third-quarter results issued after the market close on Thursday. A First Solar selloff has often occurred during quarters when Chinese solar stocks rally on earnings.

The entire solar sector slumped on Friday, but before calling an inflection point for the solar industry triggered by the First Solar earnings and outlook, let's take a look at the First Solar earnings details, which includes plenty of debatable points, and plenty of details that related more to First Solar than to the solar industry at large.

If there is one thing that was clear from the First Solar earnings it is that for a beat-and-raise quarter, it was far from clean. Whether one came away from the First Solar earnings more bearish or bullish, or with moderate expectations, First Solar didn't do itself any favors with the level of details that detracted from the overall performance, and possibly have even overwhelmed the beat-and-raise quarter as judged by the second consecutive quarter with a 9% selloff.

Here are four details related to the First Solar earnings that could be playing into the market reaction -- some justified, some possibly over-amplified.

No. 4 Key to the First Solar Selloff: Expectations Ahead of Earnings and Stock Price

First Solar was more or less trading at a 52-week high headed into earnings and according to some on the Street, the full-year whisper number was for earnings of $8. Even raising full year earnings guidance to $7.65 -- and even accounting for the 17 cents of earnings removed from the $7.65 due to the repatriation of $300 million in cash to the U.S. -- First Solar didn't meet the high-end of expectations.

First Solar shares have traded from as low as $100 in the past year and up to the mid-$150s, and given how high expectations were coming into the quarter, more or less meeting those expectations wasn't enough to justify the 52-week high levels in First Solar shares, especially given uncertainty over 2011.

Collins Stewart analyst Dan Ries, who remains bullish on First Solar, called the details "disappointing" in the First Solar report. The analyst expected the shares to come under pressure based on the fairly good optimism into the quarterly report, and added, "I'm as guilty as anyone. I thought they would really beat. Giving how the quarter played out, the earnings were sort of a dud."

Aaron Chew, analyst at Hapoalim Securities, who remains bearish on First Solar, described expectations ahead of earnings as "out of hand and really driven by a bet that guidance would reach the $8 level.

That's far from the only reason that First Solar is selling off, but the selloff does mean that First Solar may not have another positive catalyst for its shares until its 2011 guidance is issued mid-December -- and at this point, there is room for disappointment with the 2011 guidance as well.

"First Solar won't hit new lows, but will be stuck to the lower half of the $130 to $150 trading range," Chew said.

No. 3 Key to the First Solar Selloff: Expectations About Project Sales / Shifting Balance Sheet

If earnings guidance is no longer a primary catalyst for another move up in First Solar shares, neither are expectations that revenue from the sales of the Agua Caliente project would be booked before the end of the year. The timing of project revenue has always been a matter for skepticism for solar bears, with expectations that delays and lumpiness of project revenue will lead to disappointments in solar earnings from quarter to quarter, while stressing the balance sheet.

This was certainly the case with Agua Caliente (290 megawatts). First Solar went ahead and started constructing the project, spending from its own balance sheet, yet it doesn't have a buyer lined up yet, and First Solar indicated that a sale wasn't likely until 2011.

"First Solar management set expectations for financing/sale in Q1/Q2, but we view this as a slip given the 230 MW project has been actively marketed since August," said Gary Hsueh, analyst at Oppenheimer & Co.

With the Street already concerned about Northrup Grumman's appeal on First Solar's AV Solar Ranch project (230 megawatts), First Solar's NextLight pipeline "appears to be suffering from visibility issues," in the words of Oppenheimer's Hsueh. "We believe there is risk that 230 megawatts gets downsized," the Oppenheimer analyst wrote after the earnings.

Collins Stewart's Ries makes the legitimate point that First Solar was wise to go ahead and start construction on Agua Caliente this year because the Treasury Department cash-grant program for solar is expiring, and if it wants an eventual buyer to be able to access the grant, the project had to begin construction before year-end 2010.

First Solar bear Aaron Chew of Hapoalim Securities agreed more or less with the view of the Collins Stewart analyst, yet he said it doesn't change the fact it makes First Solar more vulnerable. "From a cash perspective when you start spending on a project from the balance sheet and book expenses on the assumption of what you will ultimately sell the project for, that's a big assumption," the Hapoalim Securities analyst said.

Several details in the third quarter for First Solar indicate the growing cash needs of the business. Analysts also noted that First Solar drew down its credit revolver by $100 million in the quarter, and under the "accrued expenses" line item in its quarterly financial statement, there was $100 million in accrued expenses over and above the level of accrued expenses last quarter.

First Solar was expected to file its quarterly report with the SEC in the coming days, in which details about the accrued expenses would be explained, but as of the selloff on Friday, there was no explanation for that $100 million surprise.

Of course, First Solar has by far the best balance sheet in solar. Even though debt to total assets ratio reached its highest level for First Solar in the quarter -- $250 million -- that's to be expected as the business shifts to the more cash intensive project business. It's not a lot for a company with $1 billion in assets and the cash flow generation of First Solar, but if costs on projects run higher than expected, or project sales are slower to be executed than anticipated, it's not insignificant either.

First Solar also repatriated $300 million in cash from overseas operations -- costing it 17 cents of earnings per share in the quarter. A case can be made that the $300 million repatriated from overseas makes sense, even given the earnings hit.

From a tax perspective, perhaps First Solar did the right thing, and the company still outperformed expectations even with the 17 cent hit to earnings. Yet as more of First Solar's business shifts to the North American project market, it needs more cash to fund it, and the repatriation of $300 million highlights what could be another quarter to quarter earnings surprise factor.

Aaron Chew of Hapoalim said his bearish thesis on First Solar is predicated on the fact that he came to the Street from an alternative energy project finance background, and he believes the Street is too high in terms of what it thinks First Solar will be able to sell projects for relative to the costs incurred.

No. 2 Key to the First Solar Selloff: Costs Versus ASPs

First Solar's blended average sales price dropped to $1.51 in the quarter, according to Collins Stewart (First Solar does not provide the ASP data directly). At the same time, First Solar's average cost per watt went up by a penny. The bottom line is that neither cost nor average sales price trended in the right direction in the quarter.

Collin Stewart's Ries says that the ASP drop is a matter of bean counting that can mislead investors. In fact, the analyst says First Solar's sales of modules to third-parties worked out to an ASP between $1.55 and $1.60. Yet its accounting model for blended ASP includes sales to its project business.

When the costs of a project overrun, it leads to a decrease in the accounting treatment for module sales into the project, and that's what happened in the third quarter. It doesn't explain why a project would overrun costs, and it doesn't allay the fear that First Solar projects will continue to feature cost overruns, but it doesn't indicate that sales into the open-market were commanding lower pricing.

A basic calculation using the stated 49.1% gross margin on module sales and the stated 77 cents per watt module production cost implies an average module price of $1.51/watt. That is down 12% sequentially, but due to First Solar's revenue allocation method, higher costs at its EPC division pulled down module ASPs. "We estimate that ASPs on sales to third-party customers were more consistent with our $1.55/w forecast," the Collins Stewart analyst calculated.

"There was a systems business drag, they weren't specific about what it was," the Collins Stewart analyst said in an interview with


. "I thought the price of modules and systems in Canada would be higher, but it skewed ASPs down," Ries added. "People look at the First Solar average sales pricing going down and assume there was more pricing pressure, but that's not the case for the third quarter," the analyst explained.

In any event, investors may be more concerned about First Solar's pre-emptive move to lower pricing into 2011 as a way to retain key customers in Europe ahead of feed-in tariff reductions. Christine Hersey, analyst at Wedbush Securities, said she thought the First Solar selloff might have been led by concerns about pricing in 2011.

As Stifel analysts wrote in a First Solar earnings wrap on Friday, "First Solar noted they have implemented 'price adjustments' post the recent subsidy reduction in Germany and for 2011, aiming to be a long-term supplier with 10-20 strategic customers in W. Europe and as such, has preemptively lowered prices for 2011 despite recent rhetoric from Asian competitors calling for flattish to more muted declines. We believe First Solar's cost per watt improvement program can mitigate these ASP drops and note this process is likely smoother for the end customer than relying on rebates like First Solar did in 2009."

It's typical in industries that have reached a short-term peak in pricing for the "strategic" decision to be made to lower prices as a way to solidify relationships with key customers. There's a positive way to spin this, but also a bear case to be made when a pre-emptive move to lower pricing is made, especially at a time when questions about potential pricing declines are dominating discussion.

Furthermore, if there were ever a quarter for First Solar not to be making the case that cost per watt improvements would offset price declines it was the third quarter 2010, because cost per watt, inexplicably, went up by a penny, and few saw that coming. First Solar said it was due to "proactive implementation of new equipment and processes that led to reduced yield and equipment uptime in the quarter." And that may be the case, but in the end the cost increase per watt was the exact type of negative earnings detail that helped to spur the selloff during a beat-and-raise earnings report.

No. 1 Key to the First Solar Selloff: The Outlook

First Solar's pre-emptive move to lower pricing ahead of 2011 coincided with the release of the latest data on installations from the German government's solar sector database on Friday. The level of September installations in Germany was at 492.8 megawatts, according to the German government. While that was a rebound from the August level of 360 MW installed in Germany, it was lower than July, and it was somewhat of a disappointment to some investors and analysts on the Street expecting a rebound of a higher order in September installations.

Gary Hsueh, analyst at Oppenheimer, wrote in an email to


, "I was under the impression the industry was expecting a 'rebound.' So while I didn't think that meant MW installed went back to June's 2 GW, I think most people were hoping to see 600 MW-700 MW, like July. So to me, it's marginally disappointing and I agree that it's contributing to an indiscriminate selloff. I have to wonder what module inventory will look like come January."

As the percentage of First Solar revenue moved to projects in North America in the third quarter, the percentage of revenue from Germany went down significantly. That's supposed to happen, and that's why gross margins dropped from over 48% to 40%, with systems margins at 20% for the quarter. Even First Solar bear Aaron Chew of Hapoalim Securities said the shift of revenue away from Germany, at least on a percentage basis, was a positive in the First Solar earnings. Yet it was a positive because the 2011 outlook remains a wildcard given the huge capacity building up in solar, including First Solar's 2 gigawatts of capacity.

The bull view of the pricing declines is that it will be commensurate with the feed-in tariff declines, yet the bears counter that oversupply will drive further declines in pricing. If Germany, for example, drops from 7 gigawatts in 2010 to 5 gigawatts next year, and the Czech Republic drops from over 1 gigawatt this year to almost no installations next year, that's 3 gigawatts that the solar industry needs to ship elsewhere. Italy will remain strong, the U.S. and China are growing, but what's the unaccounted-for mystery market that makes up what could be a big gap at a time of industry oversupply?

For First Solar, even with 500 MW to 700MW in North American project business in 2011, is pegging the systems business off a base of 2GW of capacity. "First Solar is filling orders outside of Germany and that's a positive. Germany will be next to nothing for them next year, so the question is how much open field installation business elsewhere in Europe they will be able to get," says the Hapoalim analyst.

Collins Stewart's Ries maintains that First Solar is a very poor read for the solar industry, due to its focus on the open-field business and its cost structure.

Solar stocks sold off broadly on Friday, but it may have only been partially due to the First Solar report, and also triggered by the numbers from Germany which have the power to set the tone for the solar outlook as much as any indicator. The Collins Stewart analyst said that a better read on solar earnings sentiment would be if Suntech Power or Yingli Solar reported and the sector sold off.

Neither of those companies reports on Monday, but a better indicator of whether the First Solar commentary will set the tone for the rest of the solar earnings season could come on Monday with the reaction to China's

Jinko Solar


and its report that all was well with the Chinese solar module sales in the third quarter. Will it set off another rally in solar shares among the Chinese solar companies, or will the larger solar outlook continue to weigh on solar sector earnings season performance?

The First Solar report didn't answer the question as to whether solar stocks are at another inflection point, though the selloff on Friday was not encouraging, but could be an isolated First Solar event.

"Lots of bears have been ready to pounce given the strong demand and volume, and the traffic of calls I'm getting from bears has picked up, with people recognizing that the Czech pushback against solar and Germany not rebounding big time ahead of the next FIT cut, and suddenly it's a situation of more module availability than we previously thought and pricing under pressure."

Yet the Hapoalim analyst doesn't necessarily say this bearish view means the Chinese stocks are going to suffer the consequences. "If you're talking about valuations getting hit, First Solar has the most room to go down. Trina is at 8x earnings, so there is a lot more air to go out of the First Solar balloon," Chew said.

-- Written by Eric Rosenbaum from New York.


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