From James LoGerfo, Michael Riedinger and Joe Berwind (Alternative Energy Investing): We are warming significantly to SunPower (SPWR), and are moving from a neutral stance on the stock to a more favorable opinion in which we now advocate exposure to SPWR shares into the coming year.
• SPWR put up yet another outsized quarter. Third Quarter 2006 sales of $65.3 million beat consensus of $61.09 and earnings of $0.13 per share was inline with consensus. The company reported further gains in its silicon usage per watt falling from 7.8 grams per watt to under 7.5 grams per watt. The company also stood by its previously stated goal to raise average efficiency to 22% from 20% today. Gross margins continued to expand in the quarter to 25.3% up from 23.5% last quarter.
• Our two key concerns about the stock have been (1) potential missteps as capacity is rapidly expanded; and (2) poly silicon supply and price risk, particularly in 2007. After four quarters as a public company, SunPower continues to smoothly execute on capacity expansion and fixed-price poly silicon supply for 2007 putting our concerns about scale-up largely to rest for the new year.
Third Quarter 2006 sales of $65.3 million beat consensus of $61.09 and earnings of $0.13 per share was inline with consensus. The company reported further gains in its silicon usage per watt falling from 7.8 grams per watt to under 7.5 grams per watt. The company also stood by its previously stated goal to raise average efficiency to 22% from 20% today. Gross margins continued to expand in the quarter to 25.3% up from 23.5% last quarter.
Pricing in the quarter for SunPower was extraordinary with an average ASP of $3.57 watt: the Company claims that it continues to target stable blended ASPs of $3.50 watt through the end of next year. That said, the company intends to incrementally increase prices as it ramps its dealer network and pushes the new SPR-315 module into the channel. Integrators are likely to accept SunPower’s pricing strategy as the trade-off between material costs including incidental materials (racks) and labor will off-set the premium.
Non-GAAP gross margins were up 100bps in the quarter to 25%. As discussed, margins were helped by operational improvements and the thin wafer initiative. Margins were also aided by an increase in average selling prices. For the second quarter or the quarter just ended ASPs on a consolidated basis was $3.57 per watt (up 3% from $3.45 in 2Q06). Company guidance anticipates ASPs and gross margins to remain firm at the current level in 4Q06.
The company reiterated its goal to exit the current year with gross margins in the range of 25% to 26%, despite additional costs associated with the ramp of line four (based on Gen-II technology) and the ramp of the company’s new module facility, which just began production in the last few weeks. Silicon costs are expected to be 10% to 15% higher next year compared to this year. Despite these formidable headwinds, management backed their previous 30% gross margin target for the second half of ’07, driven by thinner wafers (<190µm potentially in 2007 on lines 5,6 and 7), larger wafers, further efficiency gains and improved product mix.
Guidance for Q4 revenue in the range of $70 to $72 million was inline. Q4 non-GAAP net income in the range of $0.16 to $0.17 per share was also inline. Full year 2007 revenues guidance of greater than $360 million was also essentially inline with consensus of $369.8 million. Management also updated their progress on beginning line 4 (Gen-II) which they characterized as on time and on budget. The company also announced the commercial launch of its 315 watt panel which puts it head-to-head with Schott’s 310-320 watt EFG module which until now was unchallenged at this rating and 14% efficiency. Investors did not like to hear the degree to which 2007 is a back-end loaded year mostly related to factors outside of management’s control (insignificant line capacity and silicon availability).
On the conference call, management reiterated its sales and gross margin guidance for next year based on its latest silicon contract with REC. Management also narrowed its estimate of when capacity would reach 108 MW to the current quarter (previously 4q ‘06 - 1q ’07). Lastly, in an effort to diversify geographically, SunPower reported a doubling in its installer network in the USA.
On poly silicon more specifically SunPower stated that it will not see new supply until the second half of 2007. The company went on to claim that it will see silicon from DC Chemical early in 2008. We believe this is technically true but effectively irrelevant. Based on intelligence we gathered in San Jose, we believe DC’s poly silicon shipments in early 2008 will be very small, and will only begin to reach meaningful volumes in late 2008 – early 2009. Indeed, the range of silicon price declines, from -18% at the low end and over 30% on the high end relies heavily on when DC Chemical can deliver commercial volumes (beginning or year end).
AEI uncovered substantial data which suggests that the risk to SunPower’s 2007 guidance is more closely tied to technology risk associated with ramp-up of Gen-II than to the company’s poly silicon supply or next year’s average ASP.
Automated Module Assembly: In 2008, SunPower expects to have achieved a fully automated module production line that will take cells in and convert them into modules without any significant manual labor. This is in stark contrast to today’s module assemblies which are heavily dependent on cheap labor with some degree of automation. SunPower quoted module production to represent between 25% to 30% of the wholesale cost to distributors and installers. The company articulated its belief that with a fully automated line it could reduce costs between 25% to 30% of the module production cost and 700 bps of cost out on a wholesale basis. This is a significant target on a systems cost level in which the module represents approximately 14% which ranks third after wafer and installation costs including balance of system components.
On the subject of ASP, the solar industry in April-May of this year finally pushed module pricing so high that growth in the critical German market essentially ground to a halt. That price was $4.85 / watt. Since that time, contract prices have fallen to $3.78 / watt, while wholesale spot prices have remained above $4.00. As we learned in at SEIA, the approximate clearing price to reignite the German market is $3.53 / watt.
We offer the following schematic to illustrate the dynamics of the market in Germany concerning price and inventory. Given the market clearing price is above SunPower’s stated $3.50 watt price AEI thinks the risk to gross margins emanating from a sudden collapse of SunPower’s ASPs and a further collapse of prices in Germany is second to the pure technology/execution risk of ramping line-4, the first Gen-II line for the company. Secondly, given the willingness of the company’s poly silicon suppliers to cover 100% of 2007’s supply given near all of it at a fixed price (up from 80% last quarter), we think the company’s poly silicon risk has shifted from the front year to 2008 when AEI is firmly convinced DC Chemical’s supply will not come on-stream in sufficient quantities in 1Q 08. That said we see the demand returning, stable ASPs and significantly better conditions for SunPower in the coming four quarters to support the company’s share price over the intervening period.