SunPower: Beaten Down Stock Poised to Benefit From Utility-Scale Solar

SunPower (SPWRA) was a serious underperformer in 2010 and is currently down some 48% from its January 2010 highs. Meanwhile, the market is showing clear concern regarding the outlook for European solar demand. However, the changing structure of global demand, with US utility-scale solar likely to take up some of the slack, may actually play into SunPower’s strengths - in which case, the stock could be poised for a sharp rebound.

Global growth in PV demand looks set to decelerate in 2011. Figures from Solarbuzz suggest that 2010 is likely to have seen new photovoltaic installations at 16.3 GWs globally in 2010. That number is forecast to rise to 20.4 GW in 2011. However, this 25% growth rate, though respectable, is still a significant deceleration from the 117% rate of growth seen in 2010. The main drag on demand is expected to result from policy changes related to the feed-in-tariff systems in Germany, the Czech Republic and Spain.

Despite the fact that these numbers are not good, it may be the case that the difficulties in Europe are perhaps now priced in. However, investors looking to position for a recovery in solar stocks would do well to pick specific players who are likely to be well positioned to benefit from the areas of demand poised to take up the slack – most importantly, demand in China and in the US utility-scale sector.

The focus of my attention here is specifically the market for utility-scale solar in the US. Annual revenues in this market are expected to grow from some $1bn in 2010 to $8bn by 2015. Whatever growth numbers you assume, what is clear that this market is just now coming of age and will be a major driver in demand over the next 5 years. Three factors are important here –

The rollover of the 1016 Treasury Grant program for renewables agreed at the end of last year is a significant source of ongoing financial support.

At the State level, many Renewable Energy Standards are already in place. These require utilities to produce a targeted percentage of their power generation from renewables by a specific date. California has set a standard of 33% by 2020. Colorado is at 30% by 2020 for investor-owned utilities. These vary by State. However, some 37 individual States and three US Territories currently have some kind of standard in place. As a result, utilities are already planning how best to put in place the Purchasing Power Agreements (PPAs) necessary to achieve these objectives over time.

There appears to be a good chance that a deal over a Renewable Energy Standard at the Federal level could be agreed this year. No doubt such a deal will require major concessions – particularly in terms of the increased use of nuclear. Indeed, the resultant policy measure may be renamed the Clean Energy Standard and may allow nuclear to be included in some way. However, a deal is achievable. The end result is likely to set the percentage of genuine renewables at only some 15% by a date such as 2020 - however, it would cover the whole nation and would greatly boost the need for utilities to source wind and solar projects and the like. And solar is increasingly attracting attention.

Perhaps more importantly, whatever you think of the political prospects one thing is clear – utilities are taking this seriously and are already building up a pipeline. To put this in perspective, currently there are only 214 MW of utility-scale solar power projects in actual operation in the US. However, according to a survey by GreenTech Media, there are 5.4 GWs of actual signed PPAs in place – with completion of the related projects spread out between 2011 and 2014 – and a further 10 GWs of announced deals at the pre-contract stage. This is obviously a very credible pipeline. Not all of these projects will come to fruition – but the serious nature of the demand from utilities is clear.

Over the past two years, with an eye on the coming growth of this market, PV manufacturers have sought to acquire utility PV project developers – with deals including Suntech (STP) and El Solutions, MEMC (WFR) and SunEdison, First Solar (FLSR) an both NextLight and Optisolar, and, of course, SunPower and Powerlight.

What is clear is that the major winners will be the integrated PV manufacturers with strong developer pipelines and the ability to develop serious PPA capacity across the US.

First Solar (FSLR) will be a major beneficiary here. It has a major cost advantage with its thin-film technology and has its own well-established project developer pipeline. It even competes in development against its own customers. First Solar is clearly the behemoth in this market and is the most obvious play if you just want exposure to this growth area. I am long First Solar and intend to hold the position as the good news kicks in and replaces the negativity out of Europe.

However, from a valuation perspective, perhaps the real opportunity lies elsewhere – SunPower (SPWRA). SunPower offers a high quality, high efficiency version of the crystalline silicon approach to photovoltaics. However, its solar cells and panels are not particularly cost-competitive against the main Chinese players. This has been an issue for the stock.

Nevertheless, they can compete very strongly in terms of their ability to deliver large-scale integrated systems. Indeed, they are a major global player in large-scale projects. Their new Oasis integrated power plant allows a simplified approach to scalable, modular deployment. And of course, this will be delivered via their own developer pipeline, whilst large global players like Trina Solar will be forced to find developers with whom to package their panels and modules.

The point being that this new area of demand growth will play to SunPower’s strengths – perhaps forcing the market to re-price the company’s competitive position. Others are of course attempting to develop downstream integration strategies. However, First Solar and SunPower are clearly ahead of the pack.

Meanwhile, the prospect of SunPower benefiting from this growing new market has clearly not been priced in. As discussed earlier, the stock is down some 48% over the past year and the analyst consensus is set at an unconvincing Hold according to First Call.

Earnings per share expectations declined in the later part of 2009 and into 2010. Since March of last year, expectations have flat lined with no sign of a recovery – despite positive surprises in the last two earnings reports.

Currently, First Call puts the mean consensus expectation for EPS at $1.87 in 2011 and $2.22 in 2012. This is reasonable growth but as the utility-scale story plays out these numbers could shock higher.

However, the PE ratio shows the real story – reflecting a significant lack of market confidence in the valuation story. Not only has the PE ratio fallen to historically low levels and flat lined in single digits, the ratios have also almost totally converged on a forward and trailing basis – a sign of the market’s believe in a somewhat boring outlook.

On revenues of around $2.8bn the expected EPS for 2011 is around $1.87 – producing a PE ratio of a paltry 7.2 at current market prices. During the course of 2009, the PE ratio traded in the 20 to 30 times range. As the market starts to realize the extent of the coming benefit to SunPower from the US utility market, it should begin to price in a wider multiple once again.

The following table gives an overview of how sharply the stock could recover, depending on how powerful the uplift from the utility sector is. To be conservative, I have held the consensus mean expectation of FY 2011 earnings constant. The whole of the benefit in each scenario shown comes from an increased level of market confidence and a resultant improvement in the earnings multiple.

SunPower
FY 2011	Assumed PE Ratio	Consensus EPS	Resultant Price Target	Implied Price to Book
Current	7.19	1.87	13.44	0.91
Downside Risk	5	1.87	9.35	0.64
Growing Utility market revenues	15	1.87	28.05	1.91
With passage of Federal RES	20	1.87	37.40	2.54

If you accept the revenue story related to the utility demand scenario, it seems reasonable to suggest that SunPower’s PE multiple could recover to around 15 times FY 2011 EPS. This would imply a rally in the share price to $28 – a solid 105% from its currently depressed levels. Moreover, the downside risk is probably only a PE ratio of around 5. That would take the share price back below $10 – just below where it briefly traded in August. At this level, the share price would imply a valuation well below the company’s book value of $14.71, offering reasonable support.

However, on the basis that a more buoyant view of earnings is further supported by the passage of a Renewable Energy Standard (RES) at the Federal level, the PE ratio could certainly recover further. A level of around 20 is certainly possible. This would imply a rally in the share price to just above $37.

The bottom line is that this is a stock that has been beaten down, has few supporters in the analyst community and has very low valuations. And yet it is precisely well-positioned to take advantage of the one factor which may be about to add significant demand to the solar sector – i.e. a sustained increase in activity in utility-scale solar in the US. The potential here has clearly not been priced in and the risk-reward looks excellent.

Disclosure: I am long SPWRA, FSLR.