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2020 Solar Preview Part 2: SunPower's Upside Leads U.S.-Listed Western Manufacturers

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About: SunPower Corporation (SPWR), Includes: ENPH, FSLR, SEDG, TAN
by: Investing Hobo
Investing Hobo
Long/short equity, value, contrarian, solar
Summary

SunPower's recent business restructuring which includes a next-generation product line could return the company to profitability levels not seen for almost a decade.

Enphase's highly leveraged business model could continue to provide significant upside surprises as its products become increasingly accepted by the industry.

Cost metrics for First Solar's new product line appear on track to meet targets which will improve gross margin and earnings in 2020.

Significant multiple expansion in 2019 could limit SolarEdge's stock appreciation potential this year as growth is expected to decelerate.

nrel solar demand

(NREL summary of global solar demand estimates.)

The solar industry continues to confound skeptics with its continual growth. According to IHS Markit, global installations are estimated to hit 129 GW in 2019, up from 109 GW recorded in 2018. What is surprising has been the strength of global demand despite a potential 40-50% annual drop in Chinese installations due to the late timing of project approvals. However, last year's bane could end up being a boon for the 2020 global demand since Chinese installations were merely pushed forward and not eliminated. As a result, IHS Markit now expects global solar demand to hit 142 GW this year.

As the solar industry matured over the past decade, winners have slowly emerged from the pack. 2019 represented one of the best earnings years for US-listed solar manufacturing companies and their stocks have performed accordingly. The Invesco Solar ETF (TAN) rallied 66% last year compared to the S&P 500's impressive 29% annual gain. With continued growth in the industry and in combination with regional and company-specific factors, earnings for US-listed solar manufacturers should continue to expand in 2020. The second part of this two-part article focuses on US-listed Western solar manufacturers and highlights how SunPower (SPWR) could be the best performer among the seven companies reviewed.

The company rankings listed in this article are my opinions based on potential returns in 2020. Potential returns are based on my earnings expectations for each company and also take into account relative valuations at 2020 starting stock prices for each company. This article is split into two parts with the first part focusing on the top US-listed Chinese solar manufacturers while the second part focuses on leading US-listed Western solar manufacturers.

SunPower (SPWR) Overall Rank: 1

My first pick in terms of 2020 performers may surprise a lot of people. Part of SunPower's potential 2020 outperformance is due to its relative under-performance in 2019 after its stock sold off significantly late in the year. As a result, SPWR's 57% gains in 2019 actually trailed TAN's diversified gains of 66%.

For those who have followed my solar-related articles over the past decade-plus knows I have never been a fan of SunPower. A host of strategic mistakes ranging from poor supply chain management to a horrendous decade lasting procurement mistake has resulted in the company's predicament in the past couple of years. Many including myself thought bankruptcy was in play.

While I understand why some may feel SunPower is not out of the woods yet, the company's improving operating metrics and finances shown in their 2019 quarterly earnings releases has, in my view, proved management's restructuring turnaround has been progressing ahead of expectations. SunPower's recent execution above guidance levels has given credibility to its longer term strategic goals for this year and next. From management's longer term target guidance with industry factors taking into consideration, SunPower should surprise Wall Street with potentially very high levels of non-GAAP earnings in 2020 and 2021.

The combination of factors listed beyond should contribute to SunPower's significant operational improvements this year and next.

  • Since SunPower mainly operates in a protected market that at the very least tariffs solar inputs by 20% this year but is exempt itself, its legacy manufacturing disadvantages will be negated to a degree.
  • SunPower's 'A Series' next-generation product line has been projected to be much more cost effective to manufacturer. Despite a very low deployment ratio and cost metrics still, far from reaching potential, gross margin for the company's module sales have increased from -0.4% in Q1, 7.8% in Q2, and 15.9% in Q3 2019. Consolidated gross margin is expected to increase further to 16-19% in the final quarter of 2019.
  • SunPower's announcement to spin off its module manufacturing segment to a new company named Maxeon Solar Technologies will infuse the company with an additional $298 million of new capital. In addition, it may open new credit lines in China to help the full conversion of its legacy manufacturing lines to high margin A Series production.
  • New storage product revenues could account for SunPower's projected revenue growth for its installation business even if deployments do not increase on an annual basis.

US solar installations which have lagged global figures on a relative basis could grow faster than anticipated in the next two years due to factors listed below. As a result, SunPower's preliminary guidance of mid-teens revenue growth for its US installation business appears extremely conservative.

Due to the combination of factors highlighted above, I estimate SunPower's 2020 net income on a non-GAAP basis could exceed $150 million which I explained in more detail in a previous SunPower article. At SunPower's 2020 starting market capitalization of $1.28 billion, its stock could be trading below 9x current year's non-GAAP earnings.

While a high single digit valuation on ongoing operating earnings should be attractive by itself, SunPower's earnings power will start to kick into high gear in 2021 on a full conversion of legacy capacity to A Series production. At the end of Q3 2019, only 15% of targeted capacity had been converted to A Series and my 2020 estimate conservatively assumes minimal further conversion to 25% of total targeted capacity. With the complete conversion, SunPower's 2021 GAAP net income on a dollar basis could more than double my 2020 non-GAAP estimate above.

With the Maxeon spinoff, it would be more proper to refer to the combined market capitalization of both companies than using SunPower's stock price as a performance reference. The spinoff will also unlock inter-segment elimination for both Maxeon's revenues and net income. As a result, the combined reported earnings of the two companies post spinoff will be higher than what SunPower would have reported as a stand-alone company. This factor could further increase the market capitalization of both companies and increase investor returns over SunPower's 2020 starting market capitalization.

Enphase Energy (ENPH) Overall Rank: 2

Despite rallying over 650% in 2019, Enphase could still be a top performer this year among its US-listed solar manufacturing peers. While some may be cautious after last year's stellar gains, investors should always view investments for their future potential regardless of past performance. After all, the main reason ENPH traded so low in the first place was due to Wall Street's gross underestimation of its potential earnings. At the end of 2018, analysts' average estimate for 2019 non-GAAP EPS was under $0.30. Three quarters later, Wall Street tripled 2019 earnings estimates to $0.89.

Even after quintupling last year, Enphase is not unreasonably priced in relation to its growth rate. At a 2020 starting stock price of $26.13 and a projected non-GAAP EPS of $1.04, Enphase is trading at about 25x current year's earnings. Again, Wall Street solar analysts could be heavily underestimating the company's earnings potential in 2020. With the company's net income highly leveraged to shipments, current estimates calling for 17% earnings growth appear extremely conservative. While many factors listed below have been discussed in greater detail in my previous Enphase article, additional upside drivers were released in greater detail in the company's analyst day presentation last month.

Similar to SunPower, Enphase also has new storage solutions rolling out this year. Just based on projected selling prices and attach rates, revenue growth due to incremental storage solution sales could match annual expectations. According to the company, new off-grid related products could expand its addressable market by almost four times by the end of 2022.

Aside from new product offerings, Enphase's main micro-inverter product should see continued volume growth. As a US company with high revenue exposure in the USA, Enphase should benefit from the growth of US solar demand as detailed above for SunPower. Since SunPower is also a major distributor of its product, both companies are even more linked. Thus, for similar reasons why I believe SunPower could surprise to the upside also applies to Enphase. The only difference is Enphase is starting at a higher relative valuation and, thus, may have lower relative upside potential.

In addition to organic growth in Enphase's key markets, the company could also take market share from its competitors. Just based on unit sales, SolarEdge's (SEDG) third quarter power optimizer shipments of 4.59 million units surpass Enphase's micro-inverter shipments of 1.8 million in the same period. Narrowing unit shipments just to the US, SolarEdge's lead drops to 2.38 million units compared to Enphase's 1.49 million units. With a new quarterly capacity above Q3 2019's shipment levels, Enphase could slowly eat away at SolarEdge's market share lead by as much as 600-700 thousand units per quarter.

There are a number of reasons why Enphase could gain market share from SolarEdge. Perhaps the main reason is costs. Not only has the individual price of its micro-inverters dropped by over 25% in the past five years, but module output has increased due to higher cell efficiencies and larger module footprints. At the start of 2015, the average silicon-based module output ranged between 200-250 watts with higher end modules hitting 300 watts. Today's average ranges between 300-350 watts with top end exceeding 400 watts. As a result, micro-inverter costs on a per watt basis have dropped by almost half. In fact, several large online distributors are currently quoting total system kits under 6-kilowatt size slightly in Enphase's favor in terms of pricing.

At least within the US market, Enphase should have a home-court advantage in terms of brand name recognition with major installers such as SunPower distributing its micro-inverters. With the pricing disadvantage removed for most residential installations, sales volume could pick up moving forward given Q4 2019 would be the first quarter Enphase's shipments were not capacity constrained. Thus, fourth quarter results for both Enphase and SolarEdge could mark the start of a trend for 2020 shipments.

Any gain in shipments will fall almost directly to Enphase's bottom line. With its production outsourced, most of its operating costs are fixed. For example, non-GAAP operating expenses for the first nine months of 2019 only increased by $14.6 million to $69.8 million despite an 85% annual revenue increase or $190.4 million in absolute amounts. Thus, at constant gross margin, operating income should increase at a clip 50% faster than revenue growth.

How much Wall Street currently underestimates Enphase's earnings for 2020 has yet to be determined. It will unlikely be as extreme as 2019's tripling of initial estimates, but if a combination of factors described above play out even to minor degrees, I can see Enphase's 2020 non-GAAP EPS exceeding the current $1.04 estimate by 50% or more.

Canadian Solar (CSIQ) Overall Rank: 3

(Summary in part one of this article.)

Daqo New Energy (DQ) Overall Rank: 4

(Summary in part one of this article.)

JinkoSolar (JKS) Overall Rank: 5

(Summary in part one of this article.)

First Solar (FSLR) Overall Rank: 6

As highlighted in my previous First Solar article, the company's lack of transparency makes evaluating its earnings potential difficult. For an outside observer, there is no way to accurately estimate the company's finances for its solar project business. Revenue recognition delays for high dollar value project sales have caused First Solar to miss analysts' estimates by a wide margin from time to time. In addition, revaluation of some projects has caused gross margin to vary greatly in recent quarters compared to historical averages several years ago. As a result, First Solar has missed Wall Street expectations by a very wide margin in five of the past six quarters.

The First Solar's recent announcement to shift project ownership to third parties should reduce quarterly earnings volatility once the company divests its remaining project inventory. However, without historical reference for this new business model, forecasting 2020 earnings will result in a wider degree of error. While it is too early to know the operating metrics for this new business segment, at least inter-segment eliminations for the company's module sales will no longer be an uncertainty factor. As a result, estimating First Solar's base earnings on its module manufacturing and sales business should provide a fairly accurate guide on the company's annual earnings.

As I noted in my previous First Solar articles, the company's manufacturing cost targets for its new Series 6 product line appear on track despite its recent quarterly earnings misses. The future viability of First Solar will depend on achieving a low $0.20s/watt manufacturing cost target for Series 6. At a potential manufacturing cost structure of $0.23/watt in 2020, the company could earn about $0.12/watt in gross profit. This could result in a manufacturing gross profit close to $700 million or potentially close to $400 million in annual operating profits. Just from its core module manufacturing business, First Solar could earn around $3.00 in annual non-GAAP EPS.

Current Wall Street estimates for the company's 2020 earnings call for a non-GAAP EPS of $3.63. Although First Solar posted negative systems segment gross margin in the third quarter of 2019, the company should be able to easily make up the difference between its module segment earnings and Wall Street expectations with its systems segment earnings. If the gross margin for the company's remaining solar projects is closer to historical norms, there could be upside surprises to current analysts' estimates.

Since First Solar's manufacturing costs have not yet reached its optimal levels and since market pricing remains in constant fluctuation, estimating the company's manufacturing profitability entails a higher degree of uncertainty relative to its US-listed Chinese manufacturing peers. With both costs and selling prices varying by as much as 10% each relative to levels used in the above estimate, First Solar's manufacturing gross profits could vary by as much as 20%. However, with its dominant position in the US market and with current prospects for the growth of utility-scale demand this year, it is more likely earnings uncertainty tilts to the upside.

nrel us demand

(NREL summary for US solar demand.)

With a 2020 starting stock price of $55.96, First Solar trades at slightly under 16x current year's analysts' average earnings estimates of $3.63. While it is still too early to break down the company's earnings prospects for this year ahead of its official guidance, I do believe there could be a 10% upside to current Wall Street expectations if Series 6 manufacturing cost targets are achieved. Thus, from an earnings multiple standpoint, FSLR is discounted relative to the overall market. Barring additional negative earnings news, the downside for FSLR should be very limited at current levels as long as the market still values US-based companies higher than ones operating in other countries such as China.

However, given the company's near completion of its current product upgrade cycle, growth beyond 2020 should also be limited without additional capacity expansion. First Solar's higher capex costs relative to peers will also limit its ongoing growth rate after the current year. Unlike its closest direct peer SunPower that stands to benefit next year from its own product upgrade cycle, most of First Solar's earnings boost will occur this year. Thus using traditional valuation metrics which factor growth potential, FSLR's valuation should not exceed a high teens earnings multiple. Without significant multiple expansion, 2020 returns could be limited to 25-30% annual earnings growth currently projected by Wall Street.

SolarEdge Technologies (SEDG) Overall Rank: 7

SolarEdge has been one of the most consistent US-listed solar companies in terms of earnings growth since it went public in 2015. With annual non-GAAP EPS grown expected to exceed 24% in 2019, SEDG finally received the multiple expansion it rightfully deserved. After averaging a trailing P/E of 12 in the three fiscal years prior to 2019, multiples expanded to 23.6x estimated 2019 annual earnings at the stock's year-end closing price.

However, moving forward, growth is expected to slow. Non-GAAP EPS growth is expected to grow slightly under 21% this year on revenue growth of 17%. With the global solar market expected to grow at an annual clip of 10-15% in the next few years, SolarEdge's growth rate may be decelerating towards industry averages. For this reason, continued multiple expansion for SEDG may not continue and the stock's performance moving forward may be limited to its earnings growth rate.

As I noted in my previous SolarEdge article, increasing competition could limit the company's market share growth moving forward. Capacity constraints at Enphase in the first half of 2019 allowed SolarEdge to pick up considerable market share in Enphase's home turf US market. However, Enphase has realigned its capacity to expected demand and combined with strategic partnerships is expected to narrow SolarEdge's market share lead in the US market during the final quarter of 2019.

In addition, new competition from Chinese giants could limit SolarEdge's market share gains outside the US especially in the commercial solar market. While increased competitive pressures may not result in actual revenue loss, market share gains above industry growth rates may not come as easily for SolarEdge has it has in recent years.

While I initially dismissed recent chatter regarding higher failure rates for SolarEdge's inverters, the fact the company actually addressed this issue in its third quarter earnings conference call may add credibility to increased social media complaints for SolarEdge's products in the past year. I generally take consumer complaints against branded products with a grain of salt, but I did find it interesting the Better Business Bureau's rating for SolarEdge is an F while its chief competitor Enphase received an A+ rating.

Although warranty reserve ratios are not at alarming levels, it has been on the rise for SolarEdge. The table below shows the rise in warranty obligations relative to the incremental revenues generated during the same period. This ratio has almost doubled in the third quarter of 2019 compared to the annual average in fiscal 2017. In comparison, this ratio was 0.8% for Enphase in the first three quarters of 2019 or less than a sixth that of SolarEdge. While this concern will unlikely materially affect 2020 earnings at recent levels, investors should at least keep an eye on its trend moving forward.

2017 2018 Q1-Q3 2019 Q3 2019
Period Revenues 607.045 937.237 1007.437 325.01
Warranty Reserve Increase 20.436 43.015 49.528 20.716
Warranty Reserve Increase / Period Revenues 3.37% 4.59% 4.92% 6.37%

(Data compiled from SolarEdge's SEC quarterly and annual reports.)

Aside from these potential headwinds, market acceptance of SolarEdge's product line should keep its growth rate at least in line with the industry moving forward. Significant multiple expansion already occurred last year, therefore, SEDG's gains in 2020 from its starting value of $95.09 may be limited to its 20% expected EPS growth. Since current annual estimates for 2020 only reflect the annualized earnings of its most recent quarterly report, there should be a limited downside to SolarEdge's earnings this year relative to current Wall Street expectations.

However, if some of the concerns raised above materially affect the company's results and should SolarEdge miss current estimates, the stock could experience multiple contraction which could result in meaningful percentage losses from its 2020 starting value. The combination of a relatively higher multiple, decelerating earnings growth, and competitive risks are my main reasons for ranking SolarEdge at the bottom among the seven companies detailed in this article.

Final Thoughts

2020 could be a big year for solar manufacturers with high exposure and competitive advantages in the US market. Not only is the US market still subsidized by tax credits, but it is a protected market for US manufacturers. The declining effects of these two factors in the next two years could result in a significant pull-forward of demand. The levelized cost of solar has also declined below grid parity in many regions which has spurred new market demand in States that were previously minor solar markets.

In addition, US solar manufacturers including SunPower, Enphase, and First Solar are currently transitioning to next-generation products that have improved profitability metrics. While these companies carry higher valuations relative to their Chinese counterparts listed in part one, their near term growth potential could also be higher and more stable given their regional dominance in main markets such as the US. Since SunPower's transition is about a year behind, earning momentum is not expected to accelerate until this year whereas it has already occurred for Enphase last year. For this reason, SunPower's ability to surprise to the upside this year may be similar to that of Enphase last year.

Disclosure: I am/we are long SPWR, ENPH, CSIQ, DQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.