SunPower: Why You Don't See The Profits (Yet)

| About: SunPower Corporation (SPWR)

Summary

Technological superiority compared with competitors, leader in utility scale solar power market.

Earnings from sale of assets to 8point3 not recognized as sales revenue. Assets still partially remain on Sunpower's books.

Accounting procedures for one-off costs and sales to subsidiaries mean company is more profitable than first look suggests.

Ideally placed for long run prosperity in a rapidly growing market.

About SunPower

SunPower (NASDAQ: SPWR) is an integrated Solar Power Company that offers solar power solutions across the residential, commercial and utility scale platforms. SunPower is 66% owned by French oil company Total SA (NYSE: TOT) and is recognized as one of the leading companies in the Solar Power industry in terms of conversion efficiency, reliability and durability. It has the highest conversion efficiency panels available commercially at 23% and has 10GW worth of solar projects in its global construction pipeline and is responsible for the construction of the 579 MW Solar Star I and II projects, which combined represent the largest solar power station in the US.

Why SunPower is undervalued

The first thing to mention is how the profitability of SunPower is somewhat masked by the peculiar way sales to 8point3(NASDAQ: CAFD) , its joint yieldco with First Solar(NASDAQ: FSLR), are recorded. Under GAAP (Generally Accepted Accounting Principles) measures, the income it obtains from selling completed solar power systems (primarily commercial, but also some utility and residential scale holdings) to 8point3 isn`t recognised as revenue, since it is regarded as an internal transfer. The second set of numbers that the company repeatedly publishes instead follow the International Financial Reporting Standards (IFRS) do recognize this as a complete sale.

As the third quarter earnings report and estimates for Q4 2015 and FY2016 respectively show, this is no trivial difference.

GAAP Guidance

Non-GAAP Guidance (IFRS)

FY15 Revenue Estimate*

$1.25B -$1.30B

$2.50B - $2.55B

FY16 Revenue Estimate

$1.20B -$1.40B

$3.30B - $3.50B

FY15 EBITDA Estimate/ (Net Loss) Estimate attributable to shareholders*

$(415)M - $(390)M

$475M - $500M

FY16 EBITDA Estimate/ (Net Loss) Estimate attributable to shareholders

$(415)M - $(365)M

$515M - $565M

FY15 EPS *

$(1.60) - $(1.70)

$1.95 - $2.05

FY16 EPS

$( 1.50) - $(1.70)

$2.10 - $2.30

Click to enlarge

*Using FY15Q1-Q3 actual results and Q4 estimate. Figures taken from various sources obtained from the SunPower investor relations webpage.

And there is a good reason for the difference, as the GAAP measure is done with the spirit of conservatism which is what most people would like from reading anyone else's prepared accounts. GAAP measures are designed to give, from a conservative accounting standpoint, the finances of the company. These guidelines prevent accountants from hiding expenses on their balance sheet as assets and draw attention to how much money the company actually made in the financial year. The IFRS, which are more broadly adopted overseas (including comparable versions in the more regulated financial markets of the European Union and the Commonwealth of Australia), are designed to give slightly more credence to the business operations of the company, and less on the actual accounts. The big difference in this case is in the way earnings are reported.

As simply as I could try to explain it (to guide the general mechanics of the procedure), the crux of the matter is in the way project development costs are incurred under GAAP. When a project is being developed, some costs are classed as expenses incurred and others are capitalized and depreciated over time. With construction projects that have long useful lives, often a lot of the costs at the start are capitalized. This is especially true with solar power systems as a lot of the major costs (the panels, inverters, trackers and in the case solar power plants, the plant itself) are capital with useful lives and can be sold off or leased for revenue. When these completed projects are sold off to third parties, they primarily represent an increase in revenue and an increase of expenses related to the production of the system, but the asset is no longer on SunPower's books and hence no longer being depreciated or taxed. When the sale is made to 8point3 however it isn't classified as revenue because of SunPower's 50% voting interest in 8point3. The asset remains on SunPower's books and equity in earnings it obtains from the sale to 8point3 isn't recognized either. It is still being depreciated and incurs an income tax, which affects the income tax provisions number, even though this number ends up being paid by 8point3. There are also some one off costs that relate to the IPO of 8pooint3 and SunPower's November 2014 restructuring plan that don't turn up on the EBITDA but do on the net loss the GAAP guidelines attribute to shareholders. The net effect is the roughly $1Billion swing between the two numbers.

The full GAAP vs. Non-GAAP reconciliation and a thorough explanation for the differences as they relate to SunPower can be found on the company's 8-k financial filing for its FY15Q3 results.

Which numbers offer a more realistic view of the financial situation? The core issue here is that if SunPower were selling its completed projects to third party companies rather than 8point3 then the numbers would look a lot like the Non-GAAP figures provided. And yet SunPower only owns about 40% of 8point3, which means for most practical purposes it is really a separate company, with a purchase agreement with SunPower. Looking at it another way, they've sold 60% of assets with stable long term cash flows that go unrecognized right now by GAAP as they are classified as internal transfers but in total amount to about $1Billion attributable as shareholder costs. As the company (rightly, given its growth position) doesn't give out dividends, markets don't really spot the difference.

Looking at 8point3 as an independent company is also making the argument that the core business of the company is actually the production and sale of projects built around two core solar power systems: it's high end modules IBC panels with 20%-23% efficiency and its recently released Performance Series low module panels with 17%-19% efficiency, constructed on technology obtained from its acquisition of Cogenra Solar last year, delivered and installed across three sizes of products- residential, commercial and utility scale. Further, assuming a FY2015 final EPS of $2.00 and Thursday's closing stock price of 25.65, that's a 12.82 Price/Earnings ratio for an industry leading company in a sector, operating at a profit with the potential for strong growth over the next 5 years at least, and production costs that have more than halved over the last 5.

Nature of the Utility Scale Solar Power Industry

This profitability question is a very important consideration, because it illustrates the strength of SunPower's position as a leading solar power company. This in turn suggests that it is better suited than most of its competitors to take advantage of a global economic and political landscape that is increasingly looking at cost effective solar power to power our growing energy needs. This is particularly true of utility scale solar power, which is both cheaper to develop plants for and cost efficient for utilisation for consumers especially if residential scale electricity sellers are being charged for the costs of maintaining the grid, as the residents of Nevada are now finding out. And this bodes well for the two main players in the current domestic utility scale solar market, SunPower and First Solar .

This is a very important period in time for the Solar Power industry, as recognition of reducing costs and improving efficiency is expanding the geographic market for utility scale Solar Power rapidly. The volatility in oil prices and the drop in commodities across the board over the past 18 months, coupled with the halving in production costs for Solar Companies (60% in the case of SunPower) over the past 5 years, means that for the few firms with the lowest production costs, solar power is at least competitive with all other forms of energy. First Solar for example, the company with the lowest production costs due to its low module thin film Cadmium-Telluride cells makes the claim that it has a Levelized Cost of Electricity (LCOE) comparable with all other forms of electricity apart from conventional coal. SunPower on the other hand has been leading the high-end module market using its Maxeon™ Cell Panels, with the most durable, reliable and aesthetically pleasing panels in the market.

US and OECD Growth

SunPower itself deployed 1.17GW of projects in 2015, with 0.6GW of that total coming from utility scale power. It expects those numbers to increase to at least 1.7GW and 1GW respectively for 2016. Globally, the company expects deployment to increase to 4GW annually by 2019. The extension of the ITCs for solar power companies through to 2022 looks set to keep the domestic growth strong for the next half a decade.

An important milestone for SunPower was the completion of the Salvador PV Power Plant the Atacama region of Chile in January of 2015, with the 70MW power plant illustrating SunPower's ability to construct commercially viable projects in an un-subsidized OECD market. Chile is likely going to be a core market for SunPower over the coming years. The country is a net energy importer with the current government keen to see the country's solar potential more fully realized over the coming decade, with the vast sunlit areas of the Atacama Desert ideal for utility scale solar projects.

Non-OECD Growth

Capitalizing on the non-OECD demand will be a bigger issue for SunPower, as it will depend on how low exactly it can get its production costs down to. At the moment it has about 5.6GW worth of projects in the Middle East and Africa under construction and another 1.1G under construction across Asia Pacific- 350MW of that in China. In spite of this SunPower still expects its main growth driver to come from expansion across the Americas, likely because its high end modules haven't been cost effective in developing markets the way they are in industrialized ones. This makes the performance of its Performance Series Solar Panels (SunPower's low end module range) worth keeping an eye on. One such market that could be key if SunPower could find a commercially viable foothold into it would be India, with the country ambitiously 100GW of Solar Power generation within the next 6 years. India last year signed a memorandum with France to expand cooperation to help reach this goal along with other renewable energy targets, which opens the door for French firms to access a line of low-debt French Development Agency (FDA) credit for utility and residential scale solar in India. This gives SunPower's panels a reasonable window of opportunity through its parent company Total SA. Total's presence in 130 countries around the world could be a huge help to SunPower's opportunities in countries with budding solar power aspirations.

Downside risks and project financing

Perhaps the best thing about SunPower at $20-$30 is there doesn't seem to be very much downside risk. At the worst, it's hard to imagine the both the fundamentals and the market becoming particularly unfavourable any time soon. The biggest risk is perhaps associated with the company not finding the financing needed for expansion on the scale that its board of directors would like. After the completion of the Salvador Power Plant in Chile reports were ripe of a 100MW plant in the central region to Operate primarily for the mining industry of the country to be announced at the end of 2015, but the lack of news suggests that financing for such projects may be slightly harder to come by than originally anticipated. And yet this shouldn't detract from the 10GW the company already has in its global pipeline, scheduled to come online over the coming 4 years. The financing issue would most likely be most prominent (if at all) in markets that do not already have a strong solar power market. Another potential risk is that oil prices and commodity prices do increase over the next year, making investments in them profitable again, although one could argue that this has nothing to do with the profitability of SunPower's operations in and of themselves.

The possibility of an elaborate stock price drop over the next year appears quite remote, given the strength of its balance sheet, the stable nature of its revenues and the reasonable expectation that it can continue to sell off completed medium-sized projects to its 8point3 in exchange for short term liquidity and maintain at least 90% of its FY2015 estimate (non-GAAP), and its larger projects to third parties like BHE Renewables, the subsidiary of Berkshire Hathaway Energy which financed and owns the SunPower developed 570MW Solar Star Power Plant in California, the largest Solar Power Plant in the US and the second largest in the world.

Trade Logic

The logic behind the trade is quite simple. The company is profitable in an industry (solar power) that is growing rapidly and is a technological leader in its field. It has good margins and is virtually unchallenged in the area of high end module solar panels. It is in good financial health with many projects in its pipeline across the world, with over 1.1GW of power being deployed in 2015, a number that SunPower estimates will increase to at least 1.7GW in 2016. Based on performance over the past few years, one could make a solid argument that at the very least the company will continue to churn out MegaWatts in exchange for reasonable profits for years to come, even without the cost reductions the company expects to achieve through its efforts on the innovation front.

On the plus side however the potential is quite vast if SunPower can effectively utilize its current position as a tech leader in the industry and continue to grow its impressive portfolio of completed solar projects, and translate that into a healthy portfolio of pipeline projects. Importantly, it also has a business model that is very scalable. If it can achieve the annual 4.4GW deployment that it wants to by 2019 (an target the company announced on its Analyst Day presentation in November before the ITC extension in December) or reduce costs of production by 20%-30% over that same period, or both, then SunPower could see some tremendous growth in the years to come. Given the developments in the solar power industry over the past year on both the policy and efficiency fronts that target seems entirely believable. My/our recommendation is that SunPower is a long term play over the next 2-3 years at least, as the company makes good on the projects in its pipeline and although a strong Q4 earnings report and strong annual numbers could see a short term surge in the coming months. In a year that seems destined for a rather uninspiring overall stock market performance investors could do much worse than look at a long term investment in SPWR.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SPWR over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.