First Solar (FSLR) investors were very disappointed to see that Goldman Sachs (GS) downgraded the firm to sell from buy on Jan. 6. Despite a very spotty record, Goldman Sachs is widely watched and ratings changes usually prompt a strong reaction in the stock its analysts follow – at least temporarily.
Following the downgrade, First Solar’s stock dropped from $56.74 to $51.26 (9.6%). However, does FSLR deserve the downgrade or is this a great place to add the position to your portfolio?
FSLR has lagged its industry group during the last year, but there are temporary external reasons for that. Most companies in this sector are wildly unprofitable and exist solely on the largess of the Chinese, Japanese and, to a limited extent, European governments. First Solar doesn’t have quite the same advantages. However, few of the companies in this sector have positive cash flow and even fewer have profits. FSLR has both but the nature of this industry is such that these trends have been a little choppy.
The cost of inputs for FSLR’s competitors dropped significantly last year and there has been a slow structural shift away from utility-type installations that have hurt FSLR’s competitive position. When combined with a slow market, these reasons contributed to underperformance until an important acquisition in April 2013. None of these factors are expected to impair FSLR’s actual future performance, which is why the Goldman Sachs’ downgrade was so unexpected.
There is an argument to be made that the positive performance on Jan. 7 following the downgrade is nothing more than a dead-cat-bounce before the stock sells off further. As you can see in the chart below, we recommend stop losses be placed under the lows of Jan. 6 just in case this turns out to be the case. Bulls are making the opposite argument that the selloff is an over-reaction and FSLR will hit its November highs again before earnings are released later this month.
We think the latter argument is more compelling and that the selling we have seen during the last two months is overdone. First Solar dominates the industry in the United States but has been slow to gain a foothold in the bigger Asian and European markets. To deal with that issue, FSLR acquired TetraSun in order to make more inroads into the international solar-module business. Goldman Sachs is unconvinced that the entry into the module business is enough at this point, which was one of the primary reasons for the downgrade.
The acquisition gives First Solar access to the module market in Japan and around the world. Through TetraSun, FSLR has agreements with JX Nippon (Japan’s largest energy product distributor) to distribute products through 2015. We like this deal because it means FSLR doesn’t have to reinvent the wheel from scratch in one of the most important solar markets in the world. It is true that the company has been behind the curve a little, but to a certain extent that was unavoidable as a non-Chinese firm.
We like this trade but recommend that traders set a ‘bracket-order’ that consists of two parts. The first is to enter the trade if the stock is able to ‘fill the gap’ at $57.50 per share. Getting through the gap is the first step to reducing the risk of a dead cat bounce since the top and bottom of a downside-gap are very likely resistance levels. Once the entry order has been filled we recommend placing a stop at or just below the low on Jan. 6.
Solar stocks can be tricky so wide stops and appropriate position-sizing is really important. On a positive earnings report or corporate announcement it is not uncommon to see First Solar move 20%-50% overnight. This is true for both directions, so traders who are a little nervous about earnings later this January may want to buy a protective put. Buying such protection will be expensive the closer it is to the earnings report, but it should be worth the trade-off if the company surprises again to the upside.
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.