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Company Overview:

Power-One (NASDAQ:PWER) operates in two segments, inverters and power solutions. Historically they were only a power solutions company but in 2007 they entered the solar/wind inverter market. The company has manufacturing facilities in America, Canada, Italy, China and Slovakia with sales offices in various other locations around the world.

Investment Thesis:

Long PWER

I believe that PWER is undervalued and oversold. While we have seen a lull in the PV inverter market in 2011 and 2012 the market will pick up as energy demand continues to grow and solar energy will become more and more affordable. PWER has made the right moves expanding manufacturing capacity in the two fastest growing solar markets, America and China and will look to expand its market share through its continued emphasis on product reliability, service and warranty coverage. In addition to PV inverters, wind inverters and power solutions will continue to be profitable and increase revenues.

Metrics:

  • Price- $4.76
  • Market Cap- $580.55M
  • Enterprise Value- $356.55M
  • Debt- $0
  • Total Cash- $224M
  • Current ttm Free Cash Flow- $(8.53)M*
  • Shares Outstanding- 121.96M
  • Trailing P/E- 6.87
  • Forward P/E- 8.81
  • P/S- 0.56
  • Trailing EV/EBITDA- 2.21

* Levered Free Cash Flow was negative for YE 2011 due to a large tax payment in Italy, this will not reoccur in this magnitude. There were also financing costs related to the retirement of Silver Lake's preferred shares. The company returned to positive cash flows in Q1 2012.

Variant Perception:

The company could see world demand decrease stemming growth and inevitably hurting margins given plant ramp up in both America and China. This may be possible in the short term given the oversupply and continued economic state of distress.

America and China also may not reach sales forecasts and growth targets that dictate how well foreign manufacturing will do. This would also fail to take stress off the declining European markets.

Finally, if either energy becomes cheaper or solar power does not continue to become more cost effective the amount of new installations could drastically decrease.

Manufacturing Expansion:

Between 4Q2010 and 1Q2011 Power-One opened new manufacturing facilities in America and China. The two new plants have increased total capacity by 2GW. The strategic locations of these new plants will greatly benefit Power-One going forward. Demand for new PV installations in the U.S. is expected to continue growing at a high rate over the next few years. Asia is also expected to see strong growth, driven primarily by China and India.


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The ramp up costs at the new plant have been evident through the last 18 months but they have been diminishing as they near a sustainable operating capacity.

Power Solutions:

Their power conversion and power management solutions are used in computer servers, data storage, networking, telecommunications and industrial applications. They include AC/DC converters, DC/DC converters and DC power systems.

Since getting into the renewable energy market in 2007, inverters have become Power-One's main revenue stream but in 1Q2012 Power Solutions still accounted for over a third of revenues. This segment is often lost in the shadow of the inverters but they brought in revenues of over $300M last year and were cash flow positive. The segment historically reported losses but broke out to become profitable during 4Q2010 and has remained profitable as revenues continue to increase. This segment will provide a form of buffer if the PV market is worse than expected in 2H2012 and into 2013 providing a positive income stream.

Product Segmentation:

Residential/Utility/Commercial: The market is typically broken into these three segments. These segments are classified by the inverter size. As can be seen below most of the growth is expected in the residential and utility segments. Power-One competes across all of the segments and has positioned themselves well with their Aurora line of products (ranging from 2kw all the way to 1.4mw). As you can see this hits all of the segments allowing them to participate in the growth.


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Traditional Inverter: The traditional power inverter is attached to a grid of solar panels and works to convert income solar power (in a DC form) into usable electricity (AC form). The inverter is the most important part of the system because without it all the captured energy is lost before it ever enters the grid. This has been the primary reason that inverters have not experienced the degree of pricing volatility that panels or modules have, people demand high quality and are willing to pay a little more to get it. This is also a reason that Chinese manufacturers have had a hard time gaining any ground in the industry, they are perceived as being of lower quality.

Microinverter: The problem with traditional inverters has always been the fact that your whole system relies on this one device. Microinverters address this concern because they are individually installed on every panel. This allows the conversion to happen immediately and then a system controller to deal with all of the AC output on the grid. This technology has its pros and cons. On the plus side your whole system will never be shut down for inverter failure (only individual panels), it also gives you a high level of control within the system to optimize panel performance. Conversely, these inverters are much more expensive and there are a lot more moving parts that must be dealt with and maintained. Every plant must consider their situation and decide which option makes more sense.

Enphase has been making a huge push for microinverters within the market but both Power-One and SMA have similar product lines available. While this is an interesting segment and one that most likely will become more prevalent, it would seem more logical for the big players take over the market and back the products with their proven service networks. I believe that is what is happening now and will continue to happen, there are few barriers to entry and the big players now have a stake in the market which should depress start-ups' margins.

Optimizers: This is another solution to grid efficiency. Similar to a microinverter this is a panel level technology but these work with the traditionalized grid layout using a central inverter. The goal of the optimizer is to work on DC-DC panel optimization. This too allows for better systems management.

Power-One has a line of optimizers and competes with other smaller players in the market. These players are much less of a threat to Power-One though because wherever you have optimizers you will still have central inverters. Regardless, it is another step towards complete integration within Power-One.

Optimizers and Microinverters are expected to capture about 15% of the total inverter market by 2015, compared to 4% in 2011. The lion's share of this will be in residential and the majority of installments are anticipated to be optimizers. Either way I don't think this is bad for Power-One, unless over time their line of microinverters is continually outperformed by the competition. However, only time will tell on this as installations become more prevalent.


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Integrated Systems: Through the acquisition of Fat Spaniel a few years ago, Power-One provides Aurora Vision, an integrated System that leads to better grid optimization. This level of integration is becoming more common amongst the big suppliers but Power-One has done an excellent job of making these solutions available on all levels and in different capacities. This makes the job of the grid operator much easier.

Market Share:

Currently Power-One is the second largest manufacturer of PV inverters and commands over 10% of the market. They trail only SMA Solar, a German company. They were able to gain such a strong market share through quality and breadth of products, reliability, service and warranty. This year's market share gains will depend on what kind of inroads they make in America and China and what kind of demand there is in those markets.

Many new players have come into the market of late and have attempted to carve out niches for themselves. Below you will see a picture of how the market shapes out (this is a little dated but still relevant) but let me highlight a few interesting situations.

Enphase (NASDAQ:ENPH)- They have been in the news a lot over the first half of the year because of their IPO. The company's focus is on microinverters. The company is experiencing rapid growth but is bleeding cash. 1Q2012 alone saw a loss of $5.97 per share. The company only has $31M in cash left in the coffers but at their burn rate they may have to take out significant debt before the end of the year to continue operations. Most of their growth has been in the U.S. so the question becomes, can they maintain their market dominance or will other late entrants steal their growth?

Satcon (SATC)­- Satcon has been a leader in the U.S. market for years but has recently seen their market share eroded on both sides. Microinverter players like Enphase have taken residential markets by storm and big market players like SMA and Power-One have increased capacity in the U.S. and their quality brands have helped them steal market share in the utility and commercial segments. Over the past year their losses have increased ($0.11 loss in 1Q2012) and their gross margin has shrunk to 0.5%. The company also has $10M in convertible notes sitting in its' current liabilities that will definitely test liquidity this year.

Sungrow- Though China has over 60 inverter manufactures; this is the only one ranking in the top 15 of world suppliers. Chinese manufactures have had a hard time gaining quality credibility and shaking the cheap stigma assigned to them. That may change in the coming future as Chinese solar demand is expected to grow significantly. Sungrow is much more fiscally sound, with no debt and positive margins.

Sunways (NYSE:LDK)- This is an interesting situation because 33% of shares were just acquired by LDK Solar, China's leading solar provider. Furthermore, LDK just made a bid to take over the whole company. Sunways was traditionally a small German player but with the backing of a large company they could make significant gains. LDK is obviously attempting to become a vertically integrated supplier as China ramps up demand.


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I think Power-One has positioned itself very well on both a product offering and geographic standpoint to maintain its market position and potentially gain market share from SMA. They can not only compete throughout the range of residential, commercial and utility but they offer both string and microinverters and they offer integrated solutions via their monitoring systems. Quality has also remained a big question in the industry and is one of the primary reasons Power-One was able to gain share in the first place. This will be tether for prices to remain more stable than we have seen in the panel industry over the last 3 years.

Global Demand:

In the past global PV demand has come almost entirely from Europe. Accordingly so, 83% of Power-One's revenues came from Europe last year. However, global forecast see demand shifting away from Europe as countries begin to amend their FiTs. This process has already begun as following 2Q2012 most of the European policies are under review. The uncertainty of this has caused some to accelerate planned projects to have them finished before the review dates. More importantly, as demand shifts away from Europe Power-One will need to generate more revenue throughout the rest of the world. They are already beginning to do this with revenue from North America and Asia outpacing European growth. In 2010 93% of revenues came from Europe, in 2011 this was down to 83% and in 1Q2012 this trend became even more prevalent (though they did not provide exact numbers in their earnings release).

Though demand will be shifting, it is forecasted to be between 24 and 26GW in the conservative and most likely scenarios. One problem going forward is global supply which far exceeds near term expected demand. This has been a problem for the past 18 months and while prices have declined companies have been able to do a much better job of controlling the supply than other components manufactures. The supply capacity has been massively overbuilt due to an extreme shortage in 4Q2010 when demand more than doubled and supply couldn't keep pace. This will put increasing pressure on prices and margins until we see either increased demand or supply taken offline (through consolidation or insolvent companies). Power-One has seen its operating margins fall from 21% last year all the way to 8.2% in the most recent quarter (14.8% ttm). Power-One has witnessed less volatile margins because they maintained stable prices during the upswing in 2010. Going forward margins will continue to be suspect but as long as Power-One can stay on the positive side (unlike many of their competitors), I think they remain in a great position going forward.


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Power Solutions Sustainability:

The power solutions business segment is their legacy business. This had historically been unprofitable but reached profitability in 4Q2010. The company attributed this gain to an increase in sales volume and revenue which leads me to believe that this is a high fixed cost business segment. The segment has operated out of two plants (one in China and one in Slovakia) since 1998 and as far as the financial reports indicate there have been no fundamental changes made to the plants. Consensus estimates have segment revenues continuing to grow which, given the above postulations, would lead to sustained profitability. Furthermore, Power-One is a clear industry leader and as such should have pricing power; this is because its platinum-certified technology provides 94% power conversion efficiency whereas only a handful of its competitors can even achieve 92%.

The industries that the power solutions segment primarily services are data centers, telecom and computing industries. The market was estimated at $11B in 2010 and could grow to over $13B by 2014. The market itself is very fragmented and as such there are a lot of areas that Power-One has yet to diversify into yet but Steve Hogge, the company's power solutions president, said that it is their goal to expand the available market by up to $1B with an emphasis on the medical, some military/defense and transportation applications. Given the fragmentation in the market and Power-One's excellent product quality, I view further expansion in the market as highly plausible.

The segment's profitability declined slightly in 2011 but was fairly level after growing for 7 straight years. However, even with the 4% decline in segment revenue operating margins were up from 1% in 2010 to 7% in 2011. The trend continued in 1Q2012 with margins coming in at 9% (though revenue was down given global economic weakness).

Market Pricing:

There will presumably be a lot of questions regarding prices in the coming year as we continue to see cyclical weakness across the solar industry (along with reduced FiTs). As such the ability to stay profitable will be key as market pressures push prices down. In my opinion one of the best indicators of this is a firm's operating margins because it shows the flexibility a firm has to sell at competitive pricing while remaining profitable. Power-One has seen margins fall along with the rest of industry but even with the pricing collapse their margins have remained positive, unlike competitors Enphase, Advanced Energy (1% solar segment) and LDK Solar (SMA has remained positive at similar levels as Power-One, a testament to the operating efficiency of the two market leaders).

"We will meet competition on prices … As you get into a price war, it always helps to be the leader in profitability and that's currently our position and we'll use it as a competitive weapon." -Richard Thompson, President & CEO

Price deterioration is expected to continue into the future but overall revenues are expected to grow as demand turns up. IMS Research expects prices to be in the $0.21/W range with revenues at $9B in 2015. That is about a 15% drop from current levels. However calculations would indicate that Power-One had realized prices of $0.22 in 1Q2012 leading to questions of sales shift (residential historically sells at lower rates) or further weakening. Since the company doesn't break this out in their earnings report we are left to speculate but this is a number to pay close attention to in the future. 3Q2012 is going to be a very good indication because European demand is expected to fall off a bit given revised FiTs.


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Conclusion:

The solar inverter market has experienced a lot of turmoil and volatility over the last 18 months but I believe that Power-One is well positioned for a market turnaround. Their balance sheet is solid, they have a strong market share, they are geographically diverse and they have a thoroughly integrated product line. While 3Q2012 guidance will be sequentially weak I believe by 1H2013 the market will have begun to turn around. With cash per share at nearly $2 and continued positive flows, a market turn will force a more accurate upward valuation.

Source: Power-One: The Solar Lynchpin