Strategy For 2014 Solar Portfolio: Consistent Value Generation, Pt. II

Includes: CSIQ, JKS
by: Robert Dydo


Both, Canadian Solar and JinkoSolar, offer potential of double return.

Current market is discounting solar stocks on first quarter slowdown perceptions.

Canadian Solar revenue recognition is matter of time not credibility.

In the last article, I described two undervalued situations: JA Solar (NASDAQ:JASO) and Hanwha SolarOne (HSOL).

It is easy to suggest a company whose market price remains stuck in an evaluation from a year ago not reflecting recent business changes. It is a lot more difficult to determine the investment strategy involving companies that had gained market awareness and received value increases residing in the same peer group.

When the group has so much inconsistency in value recognition, focus on low-priced companies becomes dangerously attractive. The mistake, of course, does not come only from price, but the confusion over the profile of each organization. The majority of online investment magazines present Yingli Green Energy (YSE) and Canadian Solar (NASDAQ:CSIQ) in the same sentence without particular distinction, leading unexpected investors to conclusions that the same issues and similar potentials are affecting both companies.

For those who spent a large amount of time understanding the solar industry, a number of things are increasingly clear. The industry has survived. The Chinese, in particular, conquered the world in volume and continued to make solar power affordable. Some companies have advanced from a role of a manufacturer, to a path of EPC provider and solar plant owner. The survival has not been the same for all companies and past returns do not reflect future value, which is growing dynamically in exponential fashion for some. What many do not realize is that 2013 has been only the beginning of a revival, a period of correction. While it is hard to put an end to the timetable for solar, experts say we will continue to see growth for decades.

Through the same assumptions and past market behaviors, lower estimates for the first quarter seem to attract negative reactions and more attention than full-year guidance predictions, showing 50 to 100% shipment growth in some cases. In the new irony, the current market evaluations do not reflect values assigned by analysts. In unusual circumstances, those considered as experts have less restraint than the market, which can hardly differentiate between the names.

This is best illustrated in the case of JinkoSolar Holding Co., Ltd.(NYSE:JKS) and Canadian Solar Inc., two companies which have gained the most in 2013. Both companies not only show tremendous business growth in 2014, but continue to offer the best potential return among Chinese Solar. Despite those estimates, they remain locked in the down draft of market perception, offering prospects for consistent value generation for solar-ready portfolios.

Using 2014 guidance, JinkoSolar has confirmed moving into a new realm of profitability, boosted by specific capabilities of the company, which also now include the function of a consolidator of the Chinese industry. This is extremely vital since Jinko's strategy is deeply rooted in the Mainland. The fact that Jinko is able to take on assets of other companies and continues to make future acquisitions is fascinating for a company which just six quarters ago seem running out of liquidity, confirming not only exceptional transformation but management's business acumen.

JinkoSolar has the highest gross margins out of all the Chinese solar companies by some 23% over second place Canadian Solar. Its cost per watt is the best in the world. Along with the revenue-generating idea of solar plant ownership, this combination has a tremendous effect on earnings potential.

The company's business plan for 2014 includes 2.9GW of module sales, including some 400MW for its own solar plants. Numbers indicate a 50% growth year over year. In addition, the company has 700MW of ground and 400MW of distribution generation projects in the portfolio. In order to keep this goal, Jinko indicated to raise its module capacity to a level of some 3GW. To ensure predictability of its growth, the company hooked up with GCL-Poly for its polysilicon needs, a shift from the strategy of buying poly from spot.

Not many know that JinkoSolar's global presence counts only 50% of its module shipments, which explains its relatively low ASP. If the company was to increase the selling internationally, it is unassuming to see ASP go up. At the non-poly processing costs of $0.38 per watt, it is still possible with international contribution increasing, in the process of market share gains, to reach more than the 24% GM achieved in Q4.

Using 10% net income based on revenue generation from 2.5GW shipments averaging $0.65 brings $4.65 per share earnings.

Adding FiT revenues from 213MW already connected to the grid, with some 200MW assumed to be connected to the grid on behalf of over 400MW developed in 2014, Jinko can grow somewhere in the area of $6 per share in total. Friday, March 21, the closing price of $31.55 gives a ridiculously low price-to-earnings ratio (NYSE:PE) of 5.2. There is no surprise that most analysts see the stock over the $40s, which still is considered moderate, as it should be targeting at least $60.

Canadian Solar evaluations are also pointing to a lot more value than given by the market. While the Canadian incorporated company has a better chance of higher PE, due to its North American solar plant business, and continued growth in Japan, now including a portfolio of some 329MW solar plant projects, the market attention currently has been focused on the timeline of recognizing revenue instead of the ability to recognize it.

It is important to know that this condition is not a result of questions on credibility. Both companies, Canadian and Jinko, have been vindicated by the investment banking with relatively swift equity and debt offerings generating over a quarter billion dollars for each company. Canadian's operations cover harsh climate conditions of winter in Canada, and the first quarter is generally lower in volume. This is why the market's choice of applying willful blindness becomes an opportunity for those who can see beyond it.

Moving to analysis of 2014 guidance, Canadian has the largest portfolio of projects counting some 4.5GW, with 1.3GW in a late stage. The company is making plans to expand its capacity of modules to 3GW as soon as April.

During 2013, Canadian shipped 1.9GW of modules, producing 29% revenue from total solution. During 2014, shipments become 2.7GW, including some 400 to 500MW to its own projects. Using $2.9B guidance, 50% of this revenue will come from the project side of the business. The yearly growth here is 52% on shipments and 75% on revenue. Seeing those numbers, it is hard to understand the market's behavior.

In addition, 250MW of projects in China will be held to accumulate FiT revenue. Using 8% for the net income generation, $2.9B revenue can get to $232M in net income or $4.38 per share using 53M shares for the base of the calculation. FiT from the solar plants kept by Canadian can get the company closer to the $4.70 per share mark.

To illustrate this untapped potential in both companies, one needs to look to First Solar's (NASDAQ:FSLR) recently issued guidance. Using 2015 targets, Baird upgraded the stock to $87 per share, applying PE of 14.5 on $6 per share earnings.

Canadian, delivering EPS between $4.30 and $4.70, could get a price target of $65 to $68 by the end of the year, offering nearly a 100% return from Friday's March 21 closing price.

Disclosure: I am long JKS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.