The Wild Ride on First Solar (FSLR)...Should You Stay On?

This past Wednesday, First Solar (FSLR), the darling of the alternative energy industry and the largest solar energy company by market capitalization in the world, reported a tripling in 1Q09 profits with $164.6M or $1.99 EPS (bringing its trailing P/E to below 50.0x), thanks to several important developments:

-1GW of solar modules have been built by FSLR
-Average manufacturing cost dropped below $1/Watt

These are significant results in the competitive solar industry because they reaffirm FSLR's standing as the market leader - the game of solar at its current stage (secular growth) is all about cost compression, which results from efficient production technologies and economies of scale. The manufacturing cost spread is years ahead of what competitors such as Evergreen Solar (ESLR) are producing currently, thanks to FSLR's cadmium telluride technology. This quarter's results fueled a massive 25%+ rally in the shares, sending FSLR to a 7-month high near $190. Even with news of CEO Ahearn's departure.



Is this a good spot to get back on the solar wagon after the post-summer massacre in 2008? Though many analysts are optimistic about FSLR's prospects, several important hurdles in FSLR's way become increasingly dangerous as its price creeps up on bull-injected optimism in the market, and extreme (and I mean extreme) caution should be taken with investing in this industry darling. Here are several points I would like to highlight:

1) Market over-supply. While it is true that FSLR has demonstrated it is capable of acquiring new contracts and securing development deals, it is undeniable (and is actually pointed out by the CEO during the conference call) that the current credit situation makes alternative energy a secondary priority for governments and large corporations - the industry's largest investors and strongest early supporters. Prospects of oversupply (when solar panel production capacity exceeds planned orders) loom, and capital is by no means liquid again in the global financial markets. With the stress test results coming out next week, I would not be surprised if Citi and BofA are required to raise tens of billions of dollars in additional capital. The bottom line is, as well-managed and fast-paced and industry-leading as First Solar is, it is still subject to the very demons that haunt the industry as a whole, and the current valuation makes that risk all the more tangible.

2) Secular to cyclical growth. As the solar industry matures (and it is definitely doing so, at least within the alternative energy industry, since its modern version has technically been in development since Bell Lab developed the first panels back in 1953), it will likely transfer from secular growth - where industry leaders take on a demand-heavy market with limited capacity - to cyclical growth that exhibits more of a tug-and-pull structure that will be much more reliant on shifting demands of a saturated market. When we hit this phase, Alt-E companies must find ways to grow profits through avenues other than winning new contracts and growing their business - cost cutting and producting streamlining are more likely contributors to profit growth, and they sure won't generate growth worthy of the multiples some renewable energy companies trade at today.



Are we at the point where secular growth is bound to end? Most likely not, given that solar still comprise less than 1% of current power production. But remember that a) markets are driven by expectations, which tend to be very, very far-sighted for high growth equities and b) with >50% CAGR the industry is expected (and likely will be) turning out, saturation is very likely without a substantial and meaningful stride towards grid parity.

3) Departure of Ahearns. No lengthy explanation here - even if he left on his own personal accord, Ahearns has been one of FSLR's most valuable assets, from both a technological and marketing perspective. Top management turnovers almost always translate to slowed progress (well, maybe aside from the exodus of big bank CEOS last year), and that opportunity cost for a fast growing company like FSLR is nothing short of catastrophic.

Don't get me wrong - FSLR has been and probably will be one of my favorite plays in the alternative energy space, having done extensive research into their technology, corporate culture, and market history. But take this as a cautionary earning - when the bull party ends, FSLR's run-up will be compromised by profit-taking and analyst cautions, and investors who enter a position at the top will be in for a nasty surprise. Patience goes a long way in buying growth at a reasonable value, and this cannot be more true than in the case of First Solar now.

Disclosure: I do not own shares of FSLR.