[Editor's Note, March 8, 2013: Author has revised portions of this article.]
I have a really, really strong reason to believe they [Q3 and Q4] will be very strong quarters...
It is not often your hear that kind of confidence coming from the CEO of a public company, but those were the words of Sunpower's (SPWR) CEO Tom Werner during the last Q4 conference call. For a few weeks now, I have been averaging into Sunpower shares for what I consider a long term trade. Here is my general investment thesis:
A painful period of oversupply and overcapacity have forced companies like Sunpower and First Solar (FSLR) to strictly focus on margins and the efficiency of solar panels. The fruit of this intense focus is beginning to show in margins now. Uncompetitive players in the industry are slowly dying off, thus reducing the undercurrents of overcapacity and oversupply. This will eventually result in less companies producing and installing within the solar space, thus a leveling or increase of average selling prices (ASPs).
Furthermore, there is a tradeoff between cost and efficiency of a solar module. The company providing the best ratio of kilowatts produced to module cost will rule the solar space. I believe Sunpower is that company and because of Sunpower's superior product, large project business could be taken from First Solar.
Large Solar Project Segment
Solar has reached a point where the price of energy produced is competitive with fossil fuels. Companies like Warren Buffett's Mid American Energy and NRG Energy are buying up solar projects because the falling cost of solar panels make these projects more profitable. Sunpower revenue will be driven higher as the gap between solar and fossil fuels continues to close.
In the last few years, a very important trend has been developing within the solar industry. As evidenced by Sunpower's recent agreement with U.S. Bank, the banking industry is beginning to finance rooftop solar projects for consumers. This prevents the consumer from having to pay for costly solar projects all at once. It allows homeowners to make monthly payments which, by the way, they would have been paying to the electric company anyway. This trend is growing and will further propel the industry forward.
Finally, in the near term, I will use the recent weakness of First Solar earnings to acquire Sunpower shares. As 2013 progresses, the industry undercurrents discussed above will continue to improve as Sunpower delivers extremely strong Q3 and Q4 results.
Is Solar Really Viable?
In the last few years, shorting solar companies has been extremely profitable, so it is understandable that many people, especially traders, are skeptical of solar. So, let's review the viability of solar. I recommend this article from the Economist. Solar only provides one quarter of a percent of the world's energy needs, but its growth has been staggering. The foundation for this growth is a law called "Swanson's Law" (named after the founder of Sunpower, Richard Swanson). Echoing Moore's Law (transistor size and costs will halve every 18 months), Swanson's Law "suggests that the cost of the photovoltaic cells needed to generate solar power falls by 20% with each doubling of global manufacturing capacity." The law has proven to be roughly accurate as seen in the chart below.
Because solar energy costs are now in direct competition with traditional energy sources such as coal and natural gas, the Economist predicts 2013 is the year that "Alternative" solar energy will begin to be seen as normal.
The upshot is that modules used to make solar-power plants now cost less than a dollar per watt of capacity. Power-station construction costs can add $4 to that, but these, too, are falling as builders work out how to do the job better. And running a solar power station is cheap because the fuel is free.
Coal-fired plants, for comparison, cost about $3 a watt to build in the United States, and natural-gas plants cost $1. But that is before the fuel to run them is bought. In sunny regions such as California, then, photovoltaic power could already compete without subsidy with the more expensive parts of the traditional power market, such as the natural-gas-fired "peaker" plants kept on stand-by to meet surges in demand. Moreover, technological developments that have been proved in the laboratory but have not yet moved into the factory mean Swanson's law still has many years to run.
For the past 5 quarters non-GAAP margins are expanding and guidance for Q1 2013, if met, will continue the margin expansion. While responding to a Cowen and Company analyst on how Sunpower achieved it's cost cutting initiatives, CEO Tom Werner stated the following:
We're using a lot less polysilicon per watt. We've had some great success in our manufacturing engineering group on that front, which is a combination of thinner wafers, higher efficiency and better yields. So we've been able to innovate quite successfully. We're starting to ramp our Gen 3 technology, and that is a more effective, cost-effective technology. So that's a driver as well. Fab 3, our joint venture with AUO, is performing excellently. And they've driven a number of our operating metrics really favorably. So that has had a big impact. We've also been able to innovate in our module designs. We've designed some new custom materials in our module that allow us to get more energy output that are unique to SunPower. And we've done -- been able to do that, while reducing the cost. So those are the primary drivers. We have benefited as well, however, from a more cost-effective supply chain, that being the drivers, of course, glass, aluminum, silicon, where we have long-term partners. And they see, they appreciate when they see something like AVSP booked because then they know they've got a really stable partner to work with. And so working together, we've been able to wring out costs of our supply-chain.
Our customers see between 7% and 10% higher energy delivery per rated watt compared with conventional solar systems. Our new Gen 3 technology works even better, yielding further incremental energy benefit. This additional energy production represents a major cost advantage for our customers over the lifetime of their systems.
That last sentence is where the rubber meets the road. Although First Solar can manufacture panels at roughly 0.68 cents per watt to Sunpower's ability to manufacture at just under $1 per watt, the energy produced over the life of Sunpower's solar module is far greater. Said another way, less panels per square foot are needed to generate the same amount of energy.First Solar recently touted the creation of an 18.7% efficient CdTe solar cell using their thin-film process. However, the thin-film method is rapidly becoming antiquated and could cap First Solar's margins going forward. The methods used by First Solar to create panels are technologically behind those of Sunpower. Take a look at a chart from a report published in 2011 by the National Renewable Energy Laboratory. It clearly shows thin-film technologies have topped out in efficiency over the past decade.
Before discussing goals for this investment, let's take a look at another quote from CEO Tom Werner in the last conference call:
Performance for the year will be weighted more to the second half as we expect to start initial construction for the AVSP this quarter and ramp to meaningful EPC revenue and margin in Q3 of this year. Additionally, we expect that our restructuring in Europe will lead to profitability in this region in the second half. Gross margins will remain strong and operating expenses are expected to decline 10%. As a result, we see a significant increase in 2013 non-GAAP earnings per share when compared to 2012.
Looking forward, we see substantial unlocked shareholder value in both our power plant and rooftop segments. With more than 1 gigawatt in contract or under PPA at identified pricing, our power plant business now provides us significant revenue, margin and cash flow visibility over multiple years.
Our four announced California projects, CVSR, AVSP, Quinto and Henrietta, more than double the scale of our installed power plant fleet, driving the deployment of over 1 gigawatt of SunPower panels over the next 4 years and generate over $3.5 billion in revenue and approximately $1 billion of gross margin during this period.
My expectations for this investment are the following:
- I expect a spike in 3rd and 4th quarter revenue due to large projects wins. Large project wins in the solar industry have always been the main driver of increasing margins.
- The revenue spike will give a sizable boost to margins
- Last time there was a huge spike in revenue was 4Q 2010, and the stock roughly doubled from $11 to $23 during that time (seen in the YChart below).
- I believe the stock can hit $16, at a minimum, during this run-up to a "blowout" second half of the year for 2013.
- The stock is a bit extended now sitting at $12.12. I will continue to add to my position when the stock falls under the 20 day moving average which currently sits at roughly $11.
In summary I believe, over the long term, that Sunpower will reward patient investors handsomely. The backdrop of a leaner solar industry, new residential financing, superior Sunpower panels, and large project wins are all reasons to buy this company now while price to sales ratios and book values are near historic lows.
Additional disclosure: At this time of writing, I have built approximately half of my position. I will continue to average into the stock as it pulls back from recent highs.