Power-One May Interest Value Investors, But Future Demand Remains a Question Mark

Dec. 9.10 | About: Power - (PWER)

One of the tools Chain Bridge Investing uses to find equity investments is a compilation of custom screens that are executed once a month. After the screening process is complete, we spend the remainder of the month shifting through the results. Any company that appears to be a good investment on initial assessment is added to our Potential Investment Opportunity list.

Today we would like to share with you Power-One Inc. (NASDAQ:PWER), which was just added to our Potential Investment Opportunity list and looks to warrant additional research. The company’s current growth and profitability are very attractive relative to PWER’s stock price. Moreover, the company has a stable balance sheet and has experienced some recent insider buying. Nevertheless, whether this company is a good investment will be determined primarily by whether it can continue to maintain its current profitability, which is significantly higher than any of its historical results.

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The company is comprised of two reporting segments: (1) Renewable Energy Solutions (“RES”), which has grown significantly and is the primary driver behind PWER’s current growth and profitability; and (2) Power Solutions. At present, RES accounts for approximately 66% of total revenue compared to approximately 21% in fiscal year 2009. This large and significant surge in RES is due to a surge in demand for the company’s inverters from the solar energy communities. See the chart below for select historical operating data for PWER (if interested, we encourage you to run your own figures and ratios).

As mentioned above, PWER’s current revenue and profitability results are significantly better than its historical results due to a surge in demand from solar energy communities, most of them in Europe and in particular Germany, for PWER’s inverters. In Europe and Germany, much of the solar demand has been strengthened by subsidies. Nevertheless, investors seem to be concerned that as subsidies are reduced in Germany there is a potential for this newly found demand to quickly diminish, thus negatively affecting PWER’s operating results. Although the company has stated that it continues to grow in its European, American and Asian markets, it is questionable if the future growth in demand for inverters for the rest of the world is enough to offset the decline in German demand. Also, one has to wonder if the company may be over-investing in its manufacturing capacity and creating more than enough for the short to mid-term outlook.

When considering this dilemma one must also consider if the fears of a reduction in German demand do materialize, if in the long-term these fears will subside and world growth will continue to increase at a greater pace. This uncertainty seems to be the main pressure on the company’s stock price. When we research this company further, that will be the main focus of our research.

Furthermore, the investor must consider that the components of inverters are subject to supply and demand fluctuations and could possibly, in a tight market, push costs up for PWER. Some have mentioned the value of the company’s net operating losses. We view these as a positive for the company, but the company’s management has stated that there remains doubt that these will be realized. From an operations perspective, these are some of the issues and uncertainties that need to be better understood before making an investment decision on PWER.

Meanwhile, the company offers an attractive balance sheet. At present, PWER has very good liquidity and solvency positions. In particular, PWER maintains a cash balance of approximately $194.6 million, or a $1.90 of cash per share, and the lion’s share of its $39.7 million of outstanding debt does not mature until 2019. Furthermore, when examining accounts receivable and inventory, on the surface, the sudden surge in revenue that occurred during the current year does not raise any sudden red flags. Nevertheless, this is only a brief review to see if the company warrants further investigation.

Another factor that caught our attention was the fact that there has been some significant insider buying during the last four months of 2010. Such buying comes during a time when the general stock market shows that the insider-selling-to-buying ratio is extremely high. Insiders who are willing to take increased positions in their company during a time of public uncertainty is, in our view, a positive signal along with the other factors discussed above to examine this company.

We also believe that the company may offer the investor two possibilities for realizing potential gain, in a situation where revenue and profitability continue to grow. First, due to PWER’s favorable balance sheet, relatively small size, and its operations, which make it the second largest global manufacturer of the solar inverter, we do not believe it is a stretch to mention that PWER looks like a favorable acquisition candidate. Second, with a short ratio of 5.3 times a short squeeze could occur if the company continues to perform well and negative sentiment subsides.

Although surrounded by some uncertainty, a brief review of PWER and its metrics has convinced us that this company merits additional research before making an investment decision. There is a chance that this company could generate a substantial return for investors, and if we do any follow up work on it, we will be sure to make another update with a more thorough review of the company.

We found PWER through a screen that takes the results of the Magic Formula Investing screen by Joel Greenblatt and then filters those results through free cash flow and a few other operating metrics requirements. One who is interested in the other companies that resulted from this screen can view them in the chart below. Or check out the full compilation of our screens here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.