by Debra Fiakas CFA
Solar module producer First Solar, Inc. (FSLR: Nasdaq) received a boost last week from a new rating upgrade from Hold to Buy. There are at least fifteen sets of analytical eyes scrutinizing First Solar. The prevailing view on First Solar had been ‘hold’ or ‘neutral’ with a median price target of $70.00, representing a 13% return potential from the current price level.
Solar power generation has on a roll in recent years as lower solar cell prices have helped find demand at higher volumes. The U.S. Solar Energy Industries Association has forecast 25% to 50% growth in the solar market in 2016. So the enthusiasm for solar components producers like First Solar, is understandable.
However, on nearly the same day the First Solar investors saw the upgrade in FSLR, a body blow was delivered to one of First Solar’s competitors, Trina Solar Ltd. (TSL: NYSE). An analyst at a top-bracket investment bank downgraded TSL to Neutral from Buy. The mean rating on TSL has been Hold or Neutral as well. The median price target is $14.80, promising a 67% return from the current price level.
How can traders and investors make sense of these seemingly contradictory views on the solar sector? What is it about First Solar that supports a compelling bull case, while Trina Solar shares are to be avoided?
A check of estimates for the two companies provides some clues. Trina Solar missed the consensus estimate in the quarter ending September 2015 after trouncing expectations in each of the two previous quarters. This might have been why analysts following the company trimmed estimates for the quarter ending December 2015. Despite the disappointment investors might have experienced from the third quarter report and the immediate caution for the fourth quarter, estimates for the year 2016 were only trimmed by a nickel to $1.36 per share. It appears analysts with earnings models for Trina Solar are still looking for earnings growth in the 20% to 22% range in 2016. If we use that growth rate as a proxy for an earnings multiple, that would suggest a target price of $27.20.
Could it be that the analyst is simply running scared – or embarrassed – after the third quarter disappointment? The stock gapped down in trading in the first day of trading following the downgrade. Granted the entire U.S. equity market was in peril during the day and could also have influenced TSL downward. TSL now appears oversold despite continued strong money flows into the stock.
TSL is priced at 6.5 times the 2016 consensus estimate. For the price, investors get a company that delivered 20% top-line growth and converted 8.0% of sales into operating cash flow in the last twelve months. Granted sales growth has slowed from the previous two years. However, reported profitability has improved dramatically right along with higher operating cash flows.
First Solar on the other hand has been having trouble maintaining its top-line and reported only 7.6% top-line growth in the last year. Perhaps the most recent enthusiasm for FSLR it from the company’s conversion of 14.1% of sales to operating cash flow, a rate that is a bit better than its peers.
The growth forecasts for the solar sector are impressive. However, if an investor takes a more cautious view given that the rest of the world economy is in greater doubt, it seems prudent to choose the company with the financial strength to withstand slowing growth – the one that has lower leverage. Forget demand measures, growth rates and cash conversion rates.
There is $308.6 million in debt on First Solar’s balance sheet, leaving the company with a debt-to-equity ratio of 5.73. Trina Solar by contrast has deployed far more leverage with total debt of $1.5 billion and a debt-to-equity ratio of 138.68.
The duel is decided by the balance sheet.
Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.