Solar Industry Update: Concerns over 2H Fundamentals Emerging/7 June 2016/Deutsche Bank Securities Inc.
[Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 057/04/2016.
Vishal Shah/Research Analyst/(+1) 212 firstname.lastname@example.org
In this note, we provide our thoughts and most commonly asked questions
from investors following meetings with company managements and over 50
investors over the past few weeks. Our general take is that solar sector has still
not completely emerged from the shadows of SUNE bankruptcy and balance
sheet quality remains the biggest source of investor concern in the solar sector.
Complicating the investment process is the complexity of solar business
models and difficulty in modeling a path for sustainable cash flow generation.
Against this backdrop, we prefer FSLR, SPWR and VSLR.
Concerns over 2H Fundamentals Emerging
We expect fundamentals to remain challenging in 2H16 as demand from China
market could likely decline from 2H. With the US market unlikely to see the ITC
rush and no other major market expected to pick-up the slack from China
slowdown, investors are rightly concerned about the risk of oversupply from
2H16. Moreover, a significant amount of new supply is expected to come
online in 2017 raising concerns over potential pricing/margin pressure for
Resi Leasing Sector Investor Sentiment Remains the Weakest
Financing still remains the biggest question - for resi solar leasing companies,
investors are generally concerned about the net metering policy changes in a
few states such as Arizona, Nevada and implications for policy decisions in
other states. Additionally, investors are rightly concerned about the availability
of financing required to execute growth plans. Investor concerns are also
fueled by the weaker than expected fundamentals (bookings and outlook)
reported by most resi solar companies. We believe a combination of improving
bookings momentum and execution on the financing front would be required
for investor sentiment to improve. In the medium term, we also believe net
metering policy overhang would need to be resolved for resi solar stocks to
see meaningful share price appreciation. Most of these stocks are currently
trading at or below the value of operating assets and investors are not giving
any credit for the development business. VSLR remains our top pick within the
resi leasing coverage universe.
Traditional Developers/Manufacturers Also Remain In Penalty Box
For solar developers/installers such as FSLR, SPWR, 2017 earnings/EBITDA
outlook remains the biggest focus for investors. Concerns about rising Chinese
competition and impact on module segment margins along with lack of
visibility/profitability within the systems segment remains the primary investor
concern. We like both FSLR and SPWR for different reasons. In the case of
FSLR we believe concerns about 2017 earnings cliff are overblown. While we
expect 2017 earnings to decline, the magnitude of decline would be less than
feared primarily due to upside from systems segment as well as improving
margins from series 5/6 production ramp. For SPWR, we believe the 2017
EBITDA would still be similar to 2016 levels due to 600MW of capacity
expansion as well as more diversified business model mix. Pick-up in business
momentum, which could be driven by bookings outlook would be an important
catalyst for both shares, in our view.
Chinese Solar, Inverters Unlikely to Gain Near Term Traction, Remain Selective
Chinese companies remain in a tough spot - investors are concerned about
peaking margins, rising receivables and subsidy payment delays for domestic
project developers. Stocks are not discounting much value for projects that
these companies are holding on their balance sheet. Until and unless the
outlook for China market improves - both from subsidy payment and
installation volume standpoints, we do not see any meaningful catalyst for
Chinese solar stocks. Inverter companies are similarly impacted by concerns
about pricing pressure from Enphase as well as Chinese string inverter
companies. We believe margin pressure in the inverter segment is likely to
increase, however upside from the storage segment is not fully priced into
these shares and prefer SEDG within this category. Finally, the yieldcos are
challenged by weak capital markets environment and limited opportunity for
near term drop downs which in turn is impacting medium term growth
outlook. We do not expect CAFD to tap the capital markets in order to achieve
2017 dividend growth and expect shares to gradually grind higher as the
company executes on dividend targets.
Buy-Side Views/Our Take
Least-desired name on concerns that there could a liquidity event in 2016.
Investors believe 2016 guide is still aggressive (and back-end loaded). Plus the
company is really all over the place - resi leasing, now pushing direct sale and
is also entering C&I, utility scale. Additionally, the company is adding
manufacturing capacity which means the funding requirements could remain
high in the medium term. Investors are also really frustrated by a series of
earnings disappointment and remain cautious about the development of
various state level policies. Recent cash equity transaction also makes it
difficult to assess the value of underlying assets.
Despite large Total ownership and relatively attractive valuation, SPWR shares
remain out of favor due to low float and complexity in modeling
earnings/EBITDA. Considering the low market cap and potential concerns over
a sharp decline in 2017 earnings /EBITDA due to rollover of legacy projects, lot
of investors we spoke with were unwilling to spend the time and model 2017
earnings/EBITDA. Slowdown of the resi market in the U.S. and concerns over
pricing power/ramp of P-series manufacturing also remain an overhang.
One of the biggest concerns for investors is longer-term profitability of the
optimizer/inverter business model. How can SEDG maintain 30% margins in an
environment where the module players are earnings high single digit/low teens
margins and when the large leasing customers are laser-focused on bringing
costs down? The slowdown of the US resi market due to policy uncertainty
also appears to be weighing on the shares. SEDG does get credit for
simplification of the story and business model as well as strong focus on cost
reduction/differentiated product portfolio.
The single-most important question for ENPH investors is whether the
company can drive costs down fast enough and reduce cash burn while
maintaining market share? The slow growth of US DG market is also not
helping overall investor sentiment. Plus investors are getting increasingly
concerned about increased competition and pricing pressure from string
inverter companies getting into the space. The only potential positive question
we get from investors is whether this company eventually becomes an M&A
target and can successfully execute its storage strategy?
In the case of FSLR, we highlight most commonly asked investor questions
7 June 2016
Page 4 Deutsche Bank Securities Inc.
There is some uncertainty with respect to outlook of the US utility scale market,
in light of the recent stay on Clean Power Plan. Can FSRL grow bookings in
FSLR is working on a significant number of late stage bookings opportunities
which could drive book-to-bill above 1.0 in 2H16. The company is working on
close to 1GW of systems related opportunity between now and year-end. FSLR
continues to see significant amount of activity within the US (both utility scale
and C&I) – NV casinos looking to go off-grid, Apple, Amazon, community solar
are a few examples of US project activity. International markets also remain
extremely robust from a volume stand point (Morocco, Dubai, Mexico, India);
however economics remain challenging. The company plans to be mostly a
module provider in international markets.
FSLR’s revenues and earnings have been largely influenced by legacy systems
business. What’s the outlook for systems business beyond 2017?
The company still expects to recognize revenues on 1GW of systems business
from 2017 (mostly US and Japan) and is working on 2017 CODs totaling
~500MW. In terms of project sales, Moapa project will be sold this year one
way or the other. The company would be recognizing $145M in equity
earnings in 2016 (including 8Point3 contribution of ~$25M). With some of the
project push outs, we expect this number to decrease sharply in 2017.
Bookings opportunity, cadence and margins
FSLR is looking at close to 1GW of systems related bookings opportunity
between now and the year end. Majority of this systems business opportunity
appears to be in the U.S. and Japan and we believe the company would be in a
position to achieve 2H16 book-to-bill of greater than 1.0. Systems bookings
tend to be lumpy. However, mgmt remains confident of achieving 1GW+
systems shipments on an annual basis from 2017. Within the international
markets, the company mostly sees opportunity in the module business.
With risk of increased competition from Chinese module suppliers, how can
FSLR maintain component gross margins above 20%?
FSLR’s module cost as of Q3’15 were below 40c/W and with series 6 ramp, we
anticipate costs to decrease to low 30c/W levels. Series 5, 6 ramp could result
in 150-200 bps of systems margins improvement. First, capex of series 6
capacity is 40% lower compared to capex of series 4 capacity. Second, series 5
and 6 modules do not require connectors, clips and other BoS components,
which results in overall lower component as well as labor costs.
How should we think about R&D and cash requirements?
In terms of incremental R&D expenditures, FSLR does not anticipate any
incremental R&D spend on series 5/6 technology. In terms of minimum cash
requirement, FSLR believes that $500M of cash would be sufficient to
successfully compete and develop projects in the US and international markets.
Why is Jim Hughes leaving the company?
Jim’s involvement with FSLR goes back to the time when he was helping the
company develop a strategic plan. The conversation at that time and his
7 June 2016
Deutsche Bank Securities Inc. Page 5
involvement evolved into a board request to take on an executive role.
According to Jim, he was never keen to run a public company for a long period
of time. Jim completed the 4 year plan and hit every target that was laid out.
Going forward, FSLR has to make a lot of very positive decisions and both Jim
as well as the board believes it is prudent to allow new leadership to own the
strategy over the next 5 years.
What is going on with respect to near term industry fundamentals?
The entire US solar industry was gearing for end of ITC extension and given
the extension, there is a lot of uncertainty as to how 2017 fundamentals would
shape up. The CPP uncertainty is impacting timing of utility scale roll-out. On a
5 year horizon, the future has never looked brighter. The company is already
working on a significant number of projects that would be delivered in
Why did FSLR not provide specific cost/efficiency roadmaps at the Analyst
Product mix was one of the main reasons why FSLR did not provide specific
How does FSLR think about product mix?
Series 4 will remain the primary near term focus for FSLR. This is the right
product for lower labor cost markets. Series 5 on the other hand is the right
product for higher labor cost markets.