FSLR - Why I Am Not Investing In First Solar Inc. Stock

2023-06-15 11:47:29 ET

Summary

• First Solar, Inc. stock demonstrated a massive 12-month rally thanks to regulatory tailwinds.
• On the other hand, the company's financial performance over the past decade was volatile and recent quarters demonstrate weakness.
• Moreover, my valuation analysis suggests the stock is overvalued.

Investment thesis

First Solar, Inc. ( FSLR ) stock delivered a massive 12-month rally. The stock more than tripled over the past twelve months, and the major catalyst was the Inflation Reduction Act , which was signed by president Biden in August 2022. But if we look at the current market cap, my valuation analysis suggests the stock is substantially overvalued at current levels. Moreover, the company's financial performance is very unstable. I assign FSLR stock a neutral rating because I believe that multiple regulatory tailwinds are already priced in.

Company information

FSLR manufactures and sells photovoltaic [PV] solar modules with advanced thin film semiconductor technology that provides a high-performance, lower-carbon alternative to conventional crystalline silicon PV solar modules. The company owns and leases multiple production and R&D facilities worldwide, according to the latest 10-K report .

The company's fiscal year ends on December 31. FSLR generated about 93% of its FY 2022 revenue from the sale of solar modules.

Financials

If I ask you to describe FSLR's long-term financial performance with just one word, "volatile" would be the best fit. As you can see, the topline was very unstable, with massive ups and downs. Overall, the past decade's revenue CAGR was negative because massive downs outnumbered ups. As a result, profitability metrics were volatile as well. A big red flag for me is the levered free cash flow [FCF] margin ex-stock-based compensation [ex-SBC], which was negative in the last five years.

The second red flag that I see is the tiny proportion of revenue reinvested to R&D. The R&D to revenue ratio has been consistently below 5%, meaning a low commitment to innovation. In my opinion, underinvestment in innovation means a lack of the management's long-term mindset. The good sign is that S&A to revenue relationship is relatively low, demonstrating that the management keeps an eye on overheads.

To get more understanding of the current momentum, let me narrow it down to quarterly financial performance. Last quarter's earnings were disappointing because the company did not meet consensus estimates. And the revenue miss was massive.

FSLR demonstrated a massive 49% revenue growth, though the comparative performance was easy to beat. I think so because Q1 FY2022 revenue showed a 54% decline compared to the same quarter of FY2021.

Profitability metrics also look much weaker in Q1 FY 2023 compared to Q1 FY 2022. Though, on a YoY basis, the dynamic was positive.

I believe the company's balance sheet is strong enough to weather short-term headwinds. FSLR is in a solid net cash position with very low debt-to-equity metrics. Short-term liquidity is also in a robust shape. Therefore, I think that the recent weakness in quarterly performance did not affect the company's financial position much.

Also, I want to underline that the company is weak in beating consensus estimates. If you look at FSLR's earnings history , you can see that out of the last 20 quarters, the company failed to outperform consensus revenue estimates 15 times and EPS estimates 12 times.

Valuation

First Solar stock outperformed the broad market year-to-date, delivering a 32% rally. Seeking Alpha Quant suggests the stock is attractively valued, given a decent "B-" valuation grade. But, if we look at the multiples, we can see that currently, the stock trades at valuation ratios significantly above the sector median and the company's historical averages.

FSLR does not pay dividends to investors, therefore, I consider the discounted cash flow [DCF] approach as the suitable for valuation here. The discount rate I use is ten percent, which is close to the estimation from valueinvesting.io . About ten percent revenue growth is expected by consensus estimates . I consider it optimistic given the weak revenue dynamic over the past decade, but I will use it for a base-case scenario. FCF margin is tricky to project due to the historical volatility of this metric demonstrated by FSLR over the past decade. I expect FY 2023 FCF margin to be zero and that it will expand by two percentage points yearly. Assumptions look optimistic overall, but the stock still looks substantially overvalued.

Let me simulate a more aggressive scenario with an 11.5% revenue CAGR for the next decade. I use this rate because world-energy.org projects this growth pace for the solar equipment market for the next eight years. Even using more aggressive assumptions did not help the stock to leave the overvaluation zone.

I also want to demonstrate a less optimistic scenario. I think we need to look at it because the company's revenue growth was not stable over the past decade, and actually, there were only two years out of ten when the company demonstrated double-digit revenue growth. Therefore, in my pessimistic scenario, I implement a seven percent revenue CAGR for the next decade. Under the pessimistic revenue growth trajectory, the stock looks massively overvalued

Overall, the stock looks overvalued, both from the DCF perspective and the perspective of the multiple. DCF suggests overvaluation, even with long-term double-digit revenue growth.

Risks to consider

First Solar operates worldwide, meaning it is highly exposed to numerous risks. The company operates in multiple countries with completely different regulations in terms of solar energy. Adverse changes in government subsidies, tariffs, or incentives might significantly undermine the company's financial performance. Operating internationally also means FSLR is very vulnerable to foreign exchange risks. Unfavorable fluctuations in foreign exchange rates will adversely affect the company's earnings.

First Solar is a technology-driven company. I see the company's low R&D to revenue ratio as a big risk, meaning FSLR can fall behind competitors from the technological perspective. If the company fails to innovate, it will start losing market share and is ultimately likely to be out of business over the long term. Therefore, the management shall ensure that the company's offerings are technologically competitive and address the evolving technological landscape.

FSLR is a company with optimistic growth projections priced into its current market cap. On the other hand, the company's financial performance over the past decade was very unstable, meaning that the level of uncertainty regarding future financial performance is very high. The company rarely delivers above-the-consensus quarterly earnings, meaning that there is a high risk that disappointing news will be frequent.

Bottom line

Overall, FSLR stock is a "Hold". The company faces multiple headwinds and the valuation is very rich after a massive twelve months rally. I think that most of the favorable governmental incentives are already priced in, and now we should pay more attention to future cash flows. And when we discount future FCFs, the cumulative value is below the current market cap.

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