Why Canadian Solar, Inc. Is Undervalued And Overlooked

| About: Canadian Solar (CSIQ)
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Summary

The solar power industry will experience growth and improved profitability over the next 5 years.

Canadian Solar, Inc. holds a competitive advantage within the industry.

Their integration into emerging downstream markets will grow revenue and profits.

Their stock is significantly undervalued relative to comparable companies.

Technical analysis indicates that the recent sell off has created a strong buying opportunity.

(Editors' Note: This article was submitted in October as an entry in the Harvard/Seeking Alpha Stock-pitching competition held on Nov. 8, 2014).

By Jack Gantt, Alfred Teh, Ying-Hang Eng, and Saania Malik

The solar industry is set for strong growth over the next 5 years. Technology advancements will lead to exponentially decreasing costs of PV modules, and increased demand for electricity will stir revenue. Government support tactics such as Renewable Portfolio Standards will ensure that solar producers make up a larger percentage of total electric generation. We have estimated industry revenue to increase 39% over the next 5 years. Our multiple regression was based off of natural gas and coal consumption, which is representative of demand for electric generation, and industry employment level, which indicates internal growth and success.

We believe that Canadian Solar, Inc. has a competitive advantage that will allow it to match or exceed industry growth. The company is very well positioned in emerging solar markets around the globe, primarily in China and Japan. Since 2011, the Asian region has grown from 17.4% to 53.5% of total revenue. They are also a leading company in Canada, which has a fast growing market for solar as well. Revenue from this region has grown at a CAGR of 38% since 2011. They also possess a strong adaptive ability, which is essential for success and survival in a young evolving industry such as solar. Before 2011, their revenue came primarily from manufacturing activity in Europe. As that market dried up and manufacturing selling prices dropped, the company quickly integrated into downstream markets in other geographical regions to maintain growth. This overlooked quality will continue to bring the company success as the solar market inevitably changes on a global scale. As a vertically integrated company, they are quickly positioning themselves for long term success against competitors. This will result in higher profitability and the ability to scale in an industry that has struggled to establish scalability due to high capital cost. This is reflected in their EBITDA margin, which currently sits at 15.2%, compared to an industry average of 10.1%.

Canadian Solar, Inc.s revenue is generated from two main streams: their solar module segment and their solar project segment. Their primary revenue stream has been from their module manufacturing segment, making up 80% of their top line. They are, however, quickly expanding into downstream solar markets. Future revenue growth will primarily come from utility scale solar project pipelines for downstream customers. Solar project revenue grew over 400% from 2012 to 2013. Currently, their largest project pipelines are in Japan and China, the two fastest growing solar markets on the globe. Chinas solar market alone had year over year growth of 139.6% in 2013. In Japan, they have just received approval to enter the construction phase for a 150 MW project. This is only a port ion of the 495 MW that their project portfolio in Japan totals. Canadian Solar will continue to realize revenue as the portfolio continues to be developed. Based on the expected growth and production out of these emerging markets, we expect that project segment revenue will grow at an average of 30% over at least the next 4 years.

The solar project segment will be more profitable for the company as well. Utility scale projects are large enough to become scalable, and will therefore increase the companys margins as they expand this service. Due to advancements in the semiconductor industry, it is expected that solar systems will reach grid parity within the next few years. This means the cost of every solar module is equal or less than the revenue it can generate. Adding this to the fact that Canadian Solar manufacturers its own modules for their projects means profitability will see substantial improvement. With their early positioning in downstream emerging markets, the company is poised for noticeable improvement not only from the top line, but their bottom line as well.

Canadian Solar (NASDAQ:CSIQ) is significantly undervalued relative to its comparable companies. They have an equity value over sales of 1.09, compared to an industry average of 2.07. Using EV/Sales and EV/EBITDA multiples, our comparable companies analysis indicates a relative value of $56.95. Part of this upside is attributable to the fact that many solar stocks are over speculated. Our discounted cash flow valuation, however, indicates that CSIQ is undervalued from an intrinsic standpoint as well. For our model, we projected revenue based off expected returns from solar project portfolios, keeping growth in the module segment constant. The result was an expected value of $42.73. After weighting our valuations, we have determined a target price of $47.00 for CSIQ stock. This stock is fundamentally undervalued from both a relative and intrinsic standpoint, offering investors a potential upside of over 70%.

This projection is not certain, and a number of important factors could lower our valuation and upside potential. First, the solar market in China is still very risky, and complications with solar project development arising from regulation or market changes could deter the realization of revenue. Slowing growth in China could also contribute to lower sales. Second is the average selling price for solar modules. Due to oversupply in the manufacturing industry, selling prices have fallen since 2012. Should prices continue to fall, their revenue will experience set-backs, as this is currently their primary revenue segment. Finally, government support has been essential to the success of solar companies. Any change or pullback in support would result in lower market values for the company on the exchange. Based on these factors, we have determined our worst case scenario to be an upside of 19% at a price target of $33. Therefore, the stock looks to be a strong buy even with poor market conditions.

As seen from the Relative Strength Index (RSI), the company was oversold for a brief period of time as it fell below 30. However, it later picked up to return over the 30 level. From the MACD chart, it is also obvious that the stock has been on a downtrend for the last few months. Nevertheless, the MACD line (green line) is showing signs of a rebound and should cross the 9-day EMA line, shifting into an uptrend. The stochastic chart is also telling the same story as the previous two indicators, indicating that the stock has been on a downtrend and stayed in oversold territory for a while. However, it has since recovered and picked up, signaling that the stock price will recover. In addition, the short interest as a percentage of float is currently 8.22% and has decreased by almost 10% since the last short report was published. This is a sign that investors believe that the company's stock is oversold and are trying to cover their losses.

The stock's short-term outlook is positive after being oversold and sliding downwards in terms of trend line for the past few months. The recent sell off can be attributed to profit-taking amongst a volatile marketing and falling crude oil prices. The technical indicators show strong reversal signs, and therefore signal a strong buying opportunity for this undervalued stock. The short interest, as a percentage of float is currently 8.22% and has decreased by almost 10% since the last short report was published. This is a sign that investors believe that the company's stock is oversold and are trying to cover their losses.

Disclosure: Jack Gantt, Alfred Teh, and Ying-Hang Eng are all long CSIQ. However, Saania Malik has no stake in CSIQ.