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Russ Purdy
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Russ Purdy is a recent graduate of The University of South Carolina with a degree in International Business and Finance with a minor in Chinese. Russ has been investing since the age of 13.
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  • GTAT: A GARP Stock In The Solar Industry?

    GTAT: a GARP stock in the Solar Industry?

    Overview:

    Although the Solar Industry seems like a unlikely place to find a GARP stock with enough margin of safety to be deemed a worthy investment, GT Advanced Technologies (NASDAQ: GTAT) is that stock. GTAT closed at 6.12 (05/08/12) just $.04 above the 52-week low with a PE of 5.9 and a 2012E forward PE of 4.8 according to BofA Merrill Lynch. GTAT has seen a larger decline in share price in 2012 compared to the Industry even though the company remains a market leader in all areas of its business operations. The MAC Global Solar Industry Index is down 43.45% from its 2012 high, while GTAT is down 57.5% from its 2012 high. Even using a large margin of safety GTAT still has an attractive valuation, especially when coupled with the company's growth potential. GTAT has a diversified business portfolio, strong management, strong financial statements, and is currently positioning itself to remain a market leader for years to come.

    Risks:

    At the Ira Sohn Conference in 2011, Jim Chanos of Kynikos Associates presented his short of FSLR and his distaste for the Solar Industry. Not only was Chanos short FSLR, but so was David Einhorn of Greenlight Capital who has a history of realizing large returns for his investors utilizing shorts. Both Chanos and Einhorn were short FSLR until early January 2012 because of the decreasing government subsidies given to the Solar Industry, weakening financial statements, and trouble within management. Einhorn realized that the fundamentals of FSLR made it way to overvalued, but that subsequently caused GTAT to decline to the point where GTAT's fundamentals are too undervalued to ignore. GTAT has strong financial statements and solid management, but they will still be subject to the effects of lower subsidies and the potential "landing" in China.

    The Solar Industry has been around since the 1970s, before the green movement and government subsidies for alternative energies. The Industry might shrink, forcing the less competitive companies to exit the business, but the Industry itself will continue to exist until a better technology is developed. GTAT began exiting the turnkey business in late 2010 after management completed a review determining the business was not producing a high enough margin relative to other business operations. As the industry shrinks due to decreased subsidies, suppliers will begin to introduce new cost saving equipment, an area where GTAT is a market leader in equipment installation and manufacturing.

    GTAT derives a large percentage (around 93%) of the company's revenue from Asia markets. This is a potential red flag for investors because of the inherent risk of doing business in China and the slowing growth in China. Upon considering GTAT's Asian relationships more closely you find that GTAT is currently moving business operations to Hong Kong to provide better service to customers and reduce tax rates. GTAT also mitigates some of the risk associated with doing business in China by receiving over 90% payment before shipment and developing service contracts with clients. While there are still some risks associated with GTAT's business operations, the valuation of the company provides enough margin of safety to mitigate this risk.

    Company Overview: (From Company Website)

    GT Advanced Technologies a leading global provider of polysilicon production technology, and sapphire and silicon crystalline growth systems and materials for the solar, LED and other specialty markets. Our equipment and services support the growth of the Solar and LED industries and accelerate the adoption of renewable energy for a more sustainable world.

    GT Advanced Technologies leverages its core crystalline growth and materials expertise in polysilicon, photovoltaic and sapphire to deliver sustained value to our customers. Our innovative ideas and industry experience enable the evolution and commercialization of products that elevate performance, improve quality and lower manufacturing costs.

    We have a rich history of technical innovation and leadership in crystallization process technology and capital equipment for high growth markets such as solar and LED. Today, leading manufacturers around the world have come to rely on GT Advanced Technologies for the proven performance and reliability of our products and the unmatched support provided by our global service professionals.

    Growth Potential:

    Sapphire:

    GTAT has strong management that is aggressively trying to grow the company. Management is continuously diversifying the company's business portfolio through acquisitions and R&D. In 2010 GTAT acquired Crystal Systems, a leader in sapphire manufacturing. This acquisition, coupled with GTAT's existing relationships in the sapphire market has allowed GTAT to become a supplier to 6 of the top 10 LED wafer makers in the world. GTAT currently has only received acceptance on two sapphire ASF systems, which means if GTAT doesn't encounter any major problems then the sapphire business could be an area of potential massive growth for GTAT as backlogs for sapphire business increased from 184M in April, 2011 to 908M in December, 2011 with a higher margin as the weighting of equipment sales to material sales increases.

    Polysilicon:

    According to a company report GTAT had (in 2010) 70% share of installed and operating merchant market capacity in the Polysilicon business. GTAT's revenue mix toward Polysilicon has increased from 18% in FY2011 to 35% in YTD FY2012. GTAT has seen the output of CDV Reactors increase 6x since 2007 while reducing energy consumption by more than 50%. The strength in the polysilicon market will help GTAT maintain revenue streams even in a more difficult solar environment.

    PV:

    GTAT closed its acquisition of Confluence Solar in August, 2011 and should see products enter the market in CY 13/14 using propreitary "HiCz™" continuously-fed Cz ingot technology that will reduce the cost of making solar wafers while increase the efficiency and throughput. This acquisition comes on the heels of the introduction of Monocast™ technology into the market in January 2012 that also increased efficiency and reduced costs. It will be important for GTAT to continue to develop cost effective equipment to meet needs from suppliers for lower cost equipment. GTAT has 3,200 units that are available for upgrade to the Monocast™ system that could add another revenue stream. The ability to upgrade units provides potential service revenue that will be realized at a faster rate than GTAT's current backlogs in the PV market of 6-9 months, which could potential lead to GTAT surprise on earnings.

    Catalyst:

    It is also evident that management feels the shares are undervalued as GTAT repurchased program of 26.5 million shares in beginning in November 2010 and ending in April 2011. We also find in the 3Q2012 report that GTAT has authorized a $100m stock repurchase program. This signifies management thinks the stock is vastly undervalued. If we factor in an average share price as high as 10.5 (margin of safety) then we still get a dilute shares outstanding of 122.4m. In the still shot taken from my model (pictured below) we can see that this would cause EPS to come in at $1.72 or a P/E of 3.43 and cause GTAT to have earnings this quarter of .90 as oppose to consensus of .72 which would be a surprise of 25%. Let's assign are low P/E of 4.98 would then imply a 40% move in the stock. Then we see that there are 17.8m shares short of GTAT which is 14.5% of diluted shares which is 8.87 days to cover. This could cause a massive short covering that could send the stock back over 10 dollars a share for a return of over 60%.

    Value:

    The key reason GTAT is a viable investment option is the fact that it is currently undervalued in the market. Although GTAT maintains market leadership, they are currently valued at the low end of the spectrum in their respective competitor group. Below is a graph of the TTM P/E's for the companies in GTAT's competitor group over the last six months. (GTAT is the purple line at the very bottom.)

    The above graph illustrates how GTAT's P/E has change over the past 6 months relative to is competitors.

    Small Cap Comp Group

           
             

    symbol

    ATMI

    IPGP

    TSRA

    ENTG

    PLAB

    WFR

    GTAT

    Total

    Market Cap

    636

    2460

    795

    1130

    327

    752

    738

    6838

    P/E TTM

    19.4

    19.5

    33.17

    11.83

    7.87

    16.55

    4.98

     

    Weight

    0.1

    0.4

    0.1

    0.2

    0.0

    0.1

    0.1

     

    Weight P/E

    1.8

    7.0

    3.9

    2.0

    0.4

    1.8

    0.5

    17.4

    The weighted average (by market-cap) P/E is almost 4x the P/E of GTAT! But even if we use a P/E of 4.98 and the consensus EPS estimates for 2012 of 1.54 we get a share value of 7.66 which implies a 25% upside from GTAT's current price of 6.12 (05/08/2012). If we want to be a little more bullish on the stock we can look at the effects on EPS of changing revenue growth (but still use growth figures below consensus to maintain a margin of safety) and gross margin (which should increase due to changing sapphire mix and the exit of turnkey business). Below is a scenario analysis for 2012 EPS:

     

    2012 gross profit margin

    $1.68

    40.0%

    42.0%

    44.0%

    46.0%

    48.0%

    9.0%

    1.55

    1.65

    1.75

    1.85

    1.96

    8.0%

    1.54

    1.64

    1.74

    1.84

    1.94

    7.0%

    1.52

    1.62

    1.72

    1.82

    1.92

    6.0%

    1.51

    1.61

    1.70

    1.80

    1.90

    5.0%

    1.49

    1.59

    1.69

    1.79

    1.88

    4.0%

    1.48

    1.57

    1.67

    1.77

    1.87

    If we use the high end estimate 1.96 and the current P/E of 4.98 GTAT would have an implied share value of 9.76 or 60% upside from current levels. We can quickly see that increases in P/E would lead to much higher valuations for GTAT.

    But let's add in more margin of safety and determine the intrinsic value for GTAT. If we apply a high level WACC of 15%, lower margin of 25%, normal tax-rate of 36%, and use average figures over the past three years to reduce sales we get the earnings power value calculation below. This model implies zero growth just current value of the company.

    Sales Last 3 Years

    660

      

    Margin 25%

    165

      

    add back Ave Dep

    85

      

    subtract Ave Capex

    20

    (factored in higher)

    Pre-Tax

    230

      

    Tax (36%)

    82.8

      

    Available Cash

    147.2

      

    EPV of Operations

    981.3333

    Divide by WACC (15%)

    add back Cash

    170

    (factored in lower)

    Subtract Debt

    140

    (factored in higher)

    Market Cap

    1011.333

      

    Shares Outstanding

    125.89

      

    Share Price

    8.033468

      

    Even when we apply margin of safely to nearly every figure used in the model we still get an intrinsic value of 8.03 implying a 30% increase from current levels.

    Conclusion:

    Not only is management moving operations to China to be closer to customer and reduce tax rates they have also paid down their revolving credit in exchange for a lower debt obligation. Management has been aggressive in acquisitions and is even looking to break into new markets (silicon carbide) by 2014 that will further diversify the company's revenue streams. GTAT is aggressively positioning its business to counter act the potential slowdown in the solar market, and has repeatedly demonstrated that the company will not become complacent. GTAT is strategically positioned within the solar market to be able to survive in a difficult environment as subsides begin to go away for the solar energy. Solar energy will still be around even as the industry will probably struggle for the next 3-5 years, but GTAT will be able to compete by supplying equipment that reduces cost and diversifying revenue streams. GTAT has very robust financial statements and is currently valued at the low end of the industry giving the stock a lot of upside potential. When this potential growth and upside is coupled with the fact shares dilute are decreasing and that over 17.8m shares (13.9% of total shares) are currently short according to NASDAQ the likelihood of a potential breakout of GTAT's share price increases. Overall the potential upside for GTAT (even when applying adequate margin of safety) creates an attractive investment.

    Disclosure: I am long GTAT, AMSC.

    Tags: Q, Solar, FSLR, Einhorn, Chanos
    May 09 11:29 PM | Link | Comment!
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