Power-One (NASDAQ:PWER) has rapidly become the world's second-largest maker of inverters for solar cells. (Inverters convert the DC power from the cells into the A/C power used by electrical appliances.) The company just reported a blow-out third quarter, earning .40/share vs. a .03/share loss a year ago on $314 million of revenue vs. just $100 million a year ago.
When those numbers were released the stock initially traded up into the $13s, but it promptly sold off and finished last week at $9.41. With a newly revised 2011 analyst earnings consensus of $1.26, the company now has a forward PE of just 7.5, and if you net out the approximately $2/share in combined cash and cash value of its tax loss carryforwards, the company has a forward PE of less than 6.
The bear case for PWER (and, for that matter, the entire solar industry) is that Germany has been a huge part of the market this year, and because Germany is reducing its solar subsidies, the 2011 growth picture is uncertain. In fact, the world's largest inverter maker, SMA Solar, recently said that the picture is so uncertain that next year's market could be either 20% larger (thanks to growth in the world outside of Germany) or 10% smaller (because that worldwide growth isn't enough to offset the loss of a substantial part of the German business).
Even if SMA's worst-case scenario (a 10% shrinkage in the solar market for 2011) comes to pass, however, PWER is still extremely cheap while providing what's essentially a free call option on SMA's (and most solar analysts', by the way) scenario of potential 20% worldwide growth in 2011 (not to mention the inevitable high rate of solar growth over the next five years, as ever-falling cell prices continue to approach unsubsidized grid parity). So, let's look at the "worst case" scenario...
PWER did $228 million in inverter revenue last quarter (plus $85 million in revenue from other power products). In this "worst case" scenario, the company would ship 10% less product and have to charge 10% less for it, thereby generating quarterly inverter revenue of approximately $185 million ($228 million x 90% x 90%), which would be a reduction of $43 million. At the same time, the inverter portion of the COGS line would also be reduced by approximately 10% (as under this "worst case" scenario, the company would be shipping 10% less product).
Seeing as PWER doesn't separate inverter COGS from overall COGS, for this analysis let's assume that inverter COGS is 73% of total COGS because the inverter business is now around 73% of the total business. In this case, inverter COGS for Q3 would have been approximately $135 million (73% of $185 million in total COGS), and a 10% reduction in that (due to 10% less product being shipped) would be $13.5 million less in COGS, but let's call it $13 million as the company would presumably be losing a bit of "economy of scale" if it shipped slightly less product. (Bear in mind, though, that the company has recently stated that it believes it can reduce the manufacturing cost of its inverters as it cuts their prices, so this COGS figure may be overly conservative.)
Thus, by shipping 10% fewer inverters at 10% lower prices, the company would generate $43 million less quarterly revenue and have $13 million less in COGS, for a net quarterly reduction in gross profit of $30 million. If we then assume $3 million of additional net quarterly SG&A (they just opened a new U.S. plant and sales offices but may net some of that out by spending less in Europe) and a 1/3 tax rate on both figures, we wind up with a $22 million reduction in net income, which divided among the 144 million diluted shares would cut quarterly earnings by .15/share, from Q3's .40/share to a new "worst case" quarterly net of .25/share.
.25/share annualizes out to $1.00/share. If we take the company's current stock price of $9.41 and subtract from that the $3/share in cash and remaining NOLs it would have by the end of 2011 under this scenario ($2/share now + $1/share generated during next year), we get a current "2011 worst case PE" of under 6.5! Or, conversely, if we put a 10x multiple on that $1/share and add back in the cash and NOLs, we get a current "worst case fair value" of $13. And, of course, if we put a 12x multiple on the $1.26 consensus estimate and add in what should be $3/share in cash and NOLs by late 2011, we get a current fair value for the stock north of $18.
That's why I see the current sub-$10 price as, essentially, a free call option on PWER's potential, as well as being approximately 30% cheaper than fair value for even the company's "worst case" scenario.
Disclosure: Long PWER