The Short Thinking Behind First Solar

First Solar (NASDAQ: FSLR  ) has a short interest of 14%. The short interest is particularly high compared to the short interest for Chinese solar companies such as Trina Solar (NYSE: TSL  ) , which has a short interest of 5%, and Canadian Solar (NASDAQ: CSIQ  ) , which has a short interest of around 7%.

People short for different reasons. Some short for technical reasons while others short for fundamental reasons. I personally do not know why the shorts are short, but below are some conjectures.

High valuation
The valuation for First Solar seems pretty high. The forward price-to-earnings ratio is 18.88 with projected growth over the next five years at negative 9.9%. This means that analysts do not see a lot of profit in First Solar's future, and the company's earnings will likely decrease over time.

Government tax incentive dependence for a commodity industry prone to oversupply
Solar energy itself is a commodity. There is little brand loyalty, and the lowest price per watt often wins. First Solar's margins and demand curve is thus very dependent on the overall solar industry's supply and demand.

Like all other cyclical industries, the solar industry is prone to oversupply. In 2011 and 2012, the solar industry went through a period of massive oversupply due to the rollback in European tax subsidies. Solar stocks fell sharply during that period. There could eventually be another period of oversupply due to a rollback of a major government tax credit or because the Chinese companies will keep on producing solar panels to gain market share even if they lose money. In those scenarios, First Solar's stock will likely suffer. 

First Solar also operates in the utility-scale solar farm market, which has seen spotty demand. The company's backlog fell earlier in the year but has since recovered. This type of spotty demand is not as reassuring as the solar rooftop market demand, which has seen consistently strong growth rates of over 40% year over year. 

Future cadmium telluride vs silicon production costs
First Solar uses cadmium telluride for its panels while other solar companies use silicon. It is debatable which technology is better. First Solar says that cadmium telluride has a higher theoretical efficiency than silicon, but the company then bought the silicon solar start-up TetraSun for its technology. In the long run, if silicon solar panel production costs fall significantly below cadmium telluride panel or cadmium telluride plus silicon panel production costs, First Solar will be at a major disadvantage and its stock will suffer. 

Live by the sword, die by the sword
Solar stocks are story stocks. Story stocks are very likely to rise in bull markets, and we are in one of the greatest bull markets in recent memory. The stock market is up 170% from its March 6, 2009 lows. When the bull market ends, will there be the same optimism? As Warren Buffett says, a rising tide lifts all boats. What happens when the tide comes out?

No one really knows when this bull market will end. Some say this bull market is due to the unprecedented rate of quantitative easing carried out by the Federal Reserve. Many believe that the market will fall when easing ends. Because they have higher betas, story stocks will likely fall harder. 

The bottom line
First Solar shorts have been wrong for a long time. That being said, I think it is very beneficial to know what the opposite side is thinking. I personally think that the shorts are still wrong in this bull market and that the solar industry as a whole has a bright future...but that's another article.

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