First Solar (NASDAQ:FSLR) is attracting the attention of short-sellers — traders who bet on a tumbling stock price. At 23%, First Solar’s shares that are “sold short” as a percentage of total shares outstanding are at a record high. Should you bet that First Solar will fall?
To make that decision, decide whether the risks of shorting First Solar are less than the upside. And there are plenty of risks to shorting a stock. The first is that if your short bet goes bad and the price of the stock rises above where it was when you sold it, you need to write a check into your brokerage margin account. And if that stock price rises enough, the broker could force you to immediately repay your loan by buying back the stock and taking a loss.
First Solar makes photovoltaic solar power systems – it’s the world’s largest such manufacturer. Those systems include solar modules that convert sunlight into electricity. First Solar sells those components to project developers, system integrators, and renewable energy project operators.
Not only is First Solar big, but its sales have been growing fast, and it’s profitable, it has a low-risk balance sheet, and its stock is reasonably priced relative to its earnings growth. Specifically, First Solar’s sales have been growing at a 122% annual rate for the last five years and it earned $608 million in profit during the last year, a 24% net profit margin.
The company has virtually no debt (a debt/equity ratio of 0.04 way below the industry’s 0.3) — which means that it’s in no danger of running out of cash soon — and it trades at a reasonable price-to-earnings-to-growth (PEG) ratio of 1.11 — its P/E is 17.3 and its earnings are expected to grow 15.6% to $10.89 a share in 2012.
So why are short-sellers piling in to First Solar? They believe that industry supply vastly exceeds demand and that will continue to produce price cuts that will cause revenue and profit to plummet. For example, according to Bloomberg, Italy and Germany slowed development of solar projects even as two of the world’s solar-cell makers by capacity, China’s JA Solar (NASDAQ:JASO) and Suntech (NYSE:STP), were leading “an industrywide expansion of factory capacity.”
New Energy Finance estimates that this will lead to about 33% slack industry productive capacity. That’s because those new manufacturing lines will account for 9.5 gigawatts of production going online by the end of 2011 — leading to an industry total of 41.5 gigawatts — while demand is not likely to go any higher than 28 gigawatts.
This is not a huge surprise to investors, though — an index of solar stocks lost quarter of its value since reaching a 13-month high on Feb. 18. And solar cell makers have cut prices about 21% so far in 2011, according to Bloomberg.
But it’s not like this bad news is a surprise. In fact, there seems to be a Wall Street bias against solar. One curious story is that CNBC reported on May 4 that First Solar missed earnings expectations. But in fact, First Solar beat expectations by 15% — nevertheless, its stock fell 10%, according to Motley Fool.
Sure, there is excess capacity in the industry but this comes as no surprise to investors. Meanwhile, First Solar is expected to be profitable and has virtually no debt, putting it at no risk of near-term bankruptcy. Hence, the risk of a short squeeze — where short sellers are forced to buy the stock to repay the shares they borrowed from their brokers — is pretty high.
All it would take is earnings that are better than diminished expectations. The balance of risk and return from shorting First Solar shares suggests that you might not want to join those short sellers just now.
Peter Cohan has no financial interest in the securities mentioned.
