Tuesday, March 09, 2010

First Solar (NASDAQ:FSLR): Don't Try to Catch A Falling Knife; Downgrading Solar Stocks on C2H10 Oversupply Risk - JP Morgan

JP Morgan is making a big call on Alternative Energy space downgrading First Solar (NASDAQ:FSLR), Energy Conversion Devices (NASDAQ:ENER) to Underweight from Neutral and Evergreen Solar (NASDAQ:ESLR) to Neutral from Not Rated.

Firm believes this industry faces a number of supply and margin headwinds heading into C2H10. They believe these headwinds are likely to cause many solar stocks to underperform what they feel are more attractive alternative energy investments in the LED and Wind sectors which look to have better underlying fundamentals over the next 12 months.

Solar Demand Strength Is The Highlight In C1H10 as demand pull-forward in Germany is apt to drive an atypical seasonal pattern in C2010. JPM's updated global solar demand model calls for ~7.5GWs of installations in C2010 with our work suggesting ~4.5GWs of this coming in the first half of the year before Germany’s tariff reset in July drives a moderation in demand growth in C2H10. As solar stocks have historically traded in-line with volume demand, theyview this as a particularly negative indicator for the group.

- Oversupply Likely Becomes a Major Issue In C2H10 as checks continue to suggest that module makers are aggressively expanding capacity to chase market share even as many admit that supply could soon be running ahead of demand given how fast the industry is adding. To them, this feels eerily similar to what happened to the industry in C2H08-C1H09 when the market was oversupplied by as much as 30% for several quarters. In fact, the firm estimates that C2H10 oversupply could approach 3-4GWs on an annualized basis, even worse than what occurred in the prior inventory correction.

- JPM Thinks Module ASPs Will Contract 20% – If Not More – In C2H10. This should drive big margin compression and add significant risk to C10/C11 estimates as many module makers will largely be through the bulk of their poly cost reductions by mid-year and scaling of non-silicon costs will likely only provide a partial offset.

Recent checks suggest that solar module ASPs continue to trend in the same $1.80- $2.00/W range seen over the past few months. JPM expects this pricing range to persist through most of C1H10. That being said, their sources indicate that earnest discussions on C2H10 volumes, and more importantly pricing, will likely begin in mid-to-late April with early indications suggesting pricing concessions of at least 10% for most buyers of any scale. Also noteworthy is the fact that this is right around when most Chinese module vendors will have already seen the bulk of the benefits from lower polysilicon costs which, in JPM's view, should only further compound any margin pressures for the group in C2H10.

- Right Around The Corner Is Yet Another Subsidy Cut. On Jan 1, 2011 Germany is expected to make yet another subsidy cut, somewhere in the 10% range as part of the annual regression plan. This should add even further downside pressure on product demand and margins over the next 12 months. JPM says enough is enough, and recommend long-only investors look elsewhere, to LED and Wind themes, for investment ideas.

First Solar, Inc. - SPECIFIC COMMENTS:

JPM notes they are downgrading FSLR to Underweight on the back of our C2H10 supply concerns. While they realize sentiment is already negative on this name, their talks with investors suggests that the market has become extremely comfortable with the notion that FSLR’s “worst-case” 2010 EPS is around $6 and that the stock appears to be nearing a bottom. They tend to disagree and believe the stock could move meaningfully lower given pricing sensitivity work that suggests it would only take a 10% ASP decline in C2H10 to get FSLR down to $6 EPS. In the context of what they believe is big pending oversupply across the industry later this year, this would suggest there is very little margin for error in these expectations and see further downside risk to estimates.

- Downgrading FSLR from Neutral to Underweight, lowering their December 2010 price target to $85 vs. $140 previously, and reducing C10E revenue and PF EPS estimates to $2.7bn/$5.83 vs $2.8bn/$6.30 while reducing C11E revenue and PF EPS estimates to $3.0bn/$5.48 vs. $3.5bn/$5.58 previously. On valuation, JPM's $85 target is based on ~15x their C11E EPS, or in-line with our alternative energy group average.

- JPM notes they realize FSLR’s German exposure is well understood but pricing risk still appears to be underappreciated. At an estimated ~50% of sales in C2010, FSLR’s German exposure remains among the highest in the solar industry and they believe this alone creates sufficient risk heading into C2H10 given the ongoing uncertainty around demand and pricing in that key region beyond CQ2. That said, consensus estimates seem to imply no more than a 10% decline in module ASPs for FSLR in 2H10 with a similar level of decline for all of C2011. These expectations seem optimistic.

- Firm sees EPS downside of $5 for FSLR on their pricing outlook and believe this could start to drown out the $6 “worst-case” EPS scenario that the market appears to have fixated upon. On valuation, they think the market will not be willing to award more than a mid-teens multiple for stocks that are undergoing sustained pricing and margin compression the way FSLR is and as such, they believe the stock is fairly valued at ~$85, or ~15x their C11E EPS, with downside to potentially $75 as investors begin to gravitate more towards their view of sub-$6 EPS for both C10E and C11E.

Notablecalls: FSLR is going to take the heat here, not ENER or ESLR. The stock has become quite a battlegound and it looks like the bulls lost another major ally this morning.

The oversupply story isn't anything really new but the comments of another subsidy cut from Germany will surely surprise some people.

With JPM calling for $75-$85/share levels in FSLR, there will be sellers in the name today. I'm guessing the stock can trade down towards the $103 level today. I don't really see the name breaching par today just yet. But who knows.

PS: Also, do note the Solar names (especially FSLR) are crawling with shorts so the stocks are not going down in a straight line. I know several inst. players that are looking for reasons to own the names. It's just that they haven't found any...yet.

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