Manufacturers of solar systems and components have suffered as subsidies have been cut and prices have fallen faster than costs. According to Reuters, it’s a trend that may even accelerate due to a glut of unsold solar panels. Even First Solar, Inc. (FSLR), one of the low cost leaders, may find its earnings difficult to sustain – this, according to StarMine’s Earnings Quality (EQ) score which comparatively ranks companies based on the sustainability of their earnings. An analysis of FSLR’s Q2 2011 financial statements resulted in a bottom decile EQ score of 9 out of 100 relative to all North American companies.
Some troubling trends from Q2 to consider:
- Cash flow from operations (CFFO) was negative for the quarter (-$203M)
- Accounts receivable days (4Q) increased during the year (from 53 to 84 days)
- Net operating asset turnover (T4Q) was significantly below the industry median (0.8 vs. 1.9 turns)
- Inventory days (4Q) increased during the year (from 62 to 100 days)
As seen in the accompanying chart, First Solar’s cash flows have taken a sudden and dramatic hit. Red indicates when cash flow from operations (CFFO) lags net income; green when cash flow exceeds net income. Cash flow from operations for FSLR lagged net income by $264M during the Jun-11 quarter and has been negative for the last two quarters. One reason FSLR’s EQ score is low is that earnings backed by cash are typically more sustainable than earnings from non-cash sources.
In the next chart, we see a large build-up in accounts receivable days (or days sales outstanding). Increasing accounts receivable (A/R) levels often signal inefficient working capital management. Changes in A/R levels are also an important accrual item—companies with low A/R levels are more likely to sustain earnings into future periods. As seen here, the company experienced a jump in days sales outstanding during the most recent quarter, going from 53 days a year ago to 84 days in the most recent quarter. A similar build-up can be found in inventory levels, which is often a warning sign of slowing demand and future discounting.
Despite all the recent bad news plaguing the industry, the IBES consensus analyst long-term growth (LTG) rate is still 20.3%. Given the declining industry fundamentals and deteriorating earnings quality, that growth rate estimate may prove to be overly optimistic.
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