Canadian Solar: Value Diamond in the Alt. Energy Rough

Includes: CSIQ, FSLR
by: Jack Yetiv

Canadian Solar (NASDAQ:CSIQ) reported a very nice 4Q '07 Wednesday. Although CSIQ had previously guided to expected 4Q revenues of $110 to $120 million, it actually reported $127.5 million in sales despite having lost about 5 megawatts of production due to the severe weather in China recently. Had that weather impact not occurred, revenues would have been in excess of $140 million, a blowout by any measure, especially considering that 3Q '07 revenues were $97 million and given that 4Q '06 revenues were $24 million.

Here are the sequential revenues for CSIQ's 4 quarters in 2007:

$17M, $60M, $97M and $127M

CSIQ reaffirmed revenues of $650 to $750 million in 2008, but this did not include approximately $100 million in sales of a special "UMG-silicon" type of panel that CSIQ expects to sell in 2008. Indeed, it seems much more likely that CSIQ will actually sell over $750 million of solar modules in 2008, and if CSIQ exceeds the best expectations, revenues in 2008 could approach $1 billion, putting CSIQ's sales at the same level as First Solar (NASDAQ:FSLR).

CSIQ also did well on the income side, reporting 20 cents of earnings per share, a very nice sequential increase from 2 cents per share in 3Q '07 (and an even nicer change from the loss in 4Q '06).

In the release and on the conference call, CSIQ reaffirmed that they have secured essentially all of their silicon for 2008's production, and also stated that ASP's in the first half of 2008 will actually be slightly up from 2007, followed by what sounded to be a few percent decrease in ASP's in the second half of 2008. CSIQ management indicated that none of their customers were seeking double-digit ASP decreases in 2009, suggesting that ASP's in 2009 will decrease in the single-digit range from 2007's panel prices.

However, because the degree of manufacturing cost decreases (due to increases in manufacturing efficiency and decreased silicon costs) will exceed decreases in ASP's, CSIQ guided to improved gross margins from about 11.5% in 4Q '07 to about 14% in 2008. Utilizing this information, one can roughly estimate that CSIQ should make about $2/share in 2008, as follows.

Gross profit in 4Q '07 came in at $14.6 million, yielding net income of about $5.5 million. If gross margin had been 14%, gross profit would have been about $18 million, and assuming that half of that additional profit dropped to the bottom line would have yielded about $7.5 million of net income on $127 million in sales. Assuming sales of $750 million in 2008, that would yield net income of about $45 million in 2008. This does not include a penny of income to be derived from sales of UMG-based solar panels, which actually have greater profit margins than normal silicon panels.

If CSIQ sells the mid-range of its guidance in UMG panels, that should add $100 million in revenues and $10 million in net income for 2008, yielding total net income for 2008 of approximately $55 million. Since there are about 28 million shares outstanding, this yields a fair estimate of about $2/share in 2008. I believe a case can be made that earnings will be lower or higher, but I think $2/share is a very fair estimate.

Given $2 in 2008 earnings, CSIQ continues to be by far the best value in the solar space bar none, because you have here a company that will almost triple sales from 2007 to 2008, will grow income from essentially nil in 2007 to $2/share in 2008—and yet is trading at a PE of 10 against 2008 earnings? A PE of 10 may be reasonable for a boring company growing at a few percent per year, but it certainly is not reasonable for a company growing at over 1,000%.

Undoubtedly, the naysayers will raise various arguments about CSIQ, which I will address in the comments section as needed, but there is simply no logical reason to value this company at a PE of 10 against 2008 income while FSLR—which will grow both its revenues and its earnings less quickly in 2008-is being valued at a PE of nearly 100.

Given the foregoing, I believe CSIQ should be trading at $40-50 within 6 months, if not sooner, based on $2 in 2008 earnings and a very modest PE of 20-25. Of course, by mid-2008, 2009's earnings should be much more visible, and if they are at about $3 (which is what I am modeling), a forward PE of 20 against 2009 earnings could very reasonably yield a stock price of $60 or more after 2Q '08 is announced this summer.

Along with TMA and HTE, two of my other favorite plays for 2008, this could be a very good year indeed. As for CSIQ, this is even more likely if the solar tax credits in the US are renewed (very likely) or even enhanced (reasonably possible, especially if one takes new state incentives into account), and of course, all three stocks will benefit from a recovery in the economy and stock market which many (including myself) anticipate will be well underway before the end of 2008.

Disclosure: Long CSIQ