Canadian Solar Will Power Up Your Returns

Sep. 4.14 | About: Canadian Solar (CSIQ)


Canadian Solar’s latest quarter brought an improvement of 64% in the top line. Earnings converted from loss in the year-ago quarter to 95 cents per share.

Expiration of federal investment tax credit in 2016 should bring market expansion in the US, eventually helping Canadian Solar to grow its shipping volume.

A booming solar industry in China will help mitigate the impact of US and Europe tariffs on China-made products of Canadian Solar.

Positive industry prospects and better-than-industry performance confirm a buy rating.

It is said that the solar energy is the future. Due to the scarcity of oil, consumers are searching for other sources of power generation. Benefiting from that demand, Canadian Solar Inc. (NASDAQ:CSIQ) has given its investors a price return of more than 200% in one year. The company designs, develops, and manufactures solar wafers, cells and solar power products.

In this article, I will discuss the company's future potential through analyzing its operational strength first. Later, I will move on to the qualitative factors which will determine the future prospects of the company.

Second Quarter

In its latest quarter, Canadian Solar's revenue improved by 64% to $624 million on a year-over-year basis. The company shipped 42% more units than the year-ago quarter, with 45% of the business being generated abroad. In the US, the company performed really well. While in Europe, it was seen gaining traction slowly, progressing both year over year as well as sequentially.

Higher average selling price and lower module manufacturing cost led the gross margin to increase by 600 bps to 19%. This supported the operating margin to increase by a bigger 770 bps, owing to better cost management. The net result was earnings of 95 cents per share, a reversal from the loss of 29 cents in the year-ago quarter.

The firms that are developing new technologies experience higher costs in the beginning, due to research and development "R&D" expenditure. As these costs come under control, the losses turn into profits. This is the case with Canadian Solar, whose R&D expense has fallen on a year-over-year basis.

Source: GTM Research

This investment in research is going to help Canadian Solar gain a competitive advantage in a market which is growing really fast (see graph above). In the last two and a half years, the total global PV capacity has grown from 50 gigawatts to over 100 gigawatts. However, much of the future growth will be coming from the domestic market for the company, since US is one of the most underestimated solar markets in the world. By 2016, it is expected that the domestic installations will reach to 7,000-8,000 megawatts. This is a modest range; with some experts even saying that the number could easily be doubled up to 14 gigawatts by 2016.

The expansion should come due to expiring federal investment tax credit "ITC". It is expected that 30% tax credit will expire and will move to 10% federal tax credit in 2016. Presently, about 40% of the investment capital is required to come from tax equity. The remaining comes from debt or sponsor equity. Once the 30% tax credit drops to 10%, only the depreciation will be used by the sponsor equity to shelter his personal gains. Therefore, in order to benefit from ITC, consumers are going to rush to purchase solar systems until ITC comes to an end in 2016.

In the international markets, I have already told that Europe is gaining traction. For China, the current year will be the period of recovery. Many weaker firms will either leave the market or will be acquired by the stronger players. The industry will also benefit from the building boom within China, following Beijing's latest plan to have 35 gigawatts of power-generating capacity that will be installed by the year 2015. For the current year, China's goal is to install 12 gigawatts of the capacity by the year end.

This is going to benefit Canadian Solar in two ways: Since most of the company's manufacturing facilities are in China, Canadian Solar can build and sell large-scale PV projects, modified for municipal or corporate energy grid applications, at a lower cost. Secondly, the impact of the imposition of tariff by US and Europe on China-made solar products can be reduced by selling more units within China alone.

Bottom Line

At present, Canadian Solar has solar projects of 1.3 gigawatts in hand. These orders consist of self-run and joint-venture projects along with other contracts where the company provides engineering, procurement, and construction services to the clients. Recently, the company announced that it will implement a 44-megawatts module agreement with the associates of Entropy Solar Integrators and Entropy Investment Management. Under the agreement, Canadian Solar will construct seven solar farms in North Carolina this year.

These contracts are an example why the company has been able to perform better than its peers. In fact, the recent return on equity for Canadian Solar has been 25%, whereas the competitors have provided a return of negative 1%. This indicates that Canadian Solar is ahead of its rivals in utilizing its researched products.

The company expects revenue in the range of $760 million to $800 million for the next quarter, higher than the last quarter's result. The gross margin is expected to sustain at the current level. With the above mentioned strong market prospects and the investments that are allowing Canadian Solar to perform better than its peers, the company holds a future with generous returns. Investors should seriously consider buying Canadian Solar. It holds a strong buy rating.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.