Power-One's Post-Earnings Sell-Off Was a Severe Overreaction

| About: Power - (PWER)

After Thursday's close, solar inverter (and power solutions) maker Power-One, Inc. (NASDAQ:PWER) reported blow-out earnings for Q4 2010 of $0.49/share (after adjusting for a one-time litigation charge) vs. a $0.40/share consensus on $366 million in revenue vs. a $352 million consensus. However, the stock sold off severely after hours because the company provided 2011 revenue guidance of $1.1 billion to $1.3 billion vs. a $1.3 billion consensus. However, even at the very low end of that guidance I think the stock is extremely cheap. Here's why:

In earning that (adjusted) $0.49/share, the company had 40.7% gross margins on the aforementioned $366 million in revenue. Now, if PWER only makes the $1.1 billion low end of its 2011 guidance, it will average $275 million in revenue per quarter. Let's then conservatively assume that gross margins shrink from 40.7% down to 37%, yet SG&A stays at the elevated level it attained in Q4, despite the fact that we're only assuming $275 million in quarterly revenue vs. Q4's $366 million.

37% gross margin on $275 million of revenue equals approximately $102 million in quarterly gross profit vs. Q4's gross profit of approximately $149 million, which is a reduction of $47 million. If we tax-adjust that $47 million reduction at the company's 40% tax rate, we theoretically get approximately $28 million in reduced quarterly net profit (vs. Q4 2010), which divided among approximately 142 million diluted shares equals a profit reduction of approximately $0.20/share per quarter vs. Q4 2010, thereby resulting in a "low end of guidance" 2011 average quarterly profit estimate of $0.29/share.

If we then annualize that $0.29/share, we get a low-end 2011 EPS estimate of approximately $1.16. If we put just a 13x multiple on that (and please keep in mind that IMS research has recently estimated that the solar inverter sector is growing at a compounded annual rate of 25%), we get a share price of $1.16 x 13 = approximately $15/share, plus what should be approximately $3/share of year-end cash and NOLs, for a "low end of guidance" fair value for PWER of approximately $18/share.

I do realize that this is a somewhat rough, "back of the envelope" analysis, but nevertheless there seems to be an extremely large margin of safety built into PWER's after-hours closing stock price of $9.21/share.

Disclosure: I am long PWER.