Like many others, I believe that renewable energy is the future. Governments will need to invest in renewable energy sources to address global warming. However, it doesn't mean that all companies in the sector will do well, though. In this analysis, I will investigate Canadian Solar to determine if it is a renewable energy company worth investing in and at what price.
This is not a financial advice. I am not a financial advisor and I only do these post in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that I own shares in Canadian Solar. However, I will not let my ownership of the company influence this analysis, and I will try to remain as unbiased as possible. If you would like to view or make a copy of my portfolio, you can find instructions on how to access it here. If you want to purchase shares or fractional shares of Canadian Solar, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started on investing with as little as $100.
Canadian Solar is a company that manufactures solar modules for residential and commercial systems and operates large-scale solar projects. They also have a relatively new battery storage division. The company was founded in Canada in 2001 and has subsidiaries in more than 24 countries across 6 continents. China is the largest market as it contributed 28% of revenue in 2023, followed by EMEA (25%), North America (22%), Latin America (13%), and Asia excluding China accounts for 12% of the total. Canadian Solar operates in two segments: CSI, which designs, develops, and manufactures solar ingots, wafers, cells, modules, and battery storage products. In 2023, CSI contributed approximately 93% of the revenue. The other segment is called Recurrent Energy, which develops utility-scale solar and energy storage projects. Recurrent energy contributed approximately 7% of the revenue in 2023. They are also collaborating with both Ikea and Amazon, utilizing their solar panels on warehouses worldwide. I have been researching the unique qualities of Canadian Solar compared to other manufacturers to assess if the company has a moat. Canadian Solar is widely regarded as offering the best value for money. Their panels are less efficient than the most efficient solar panels; however, they are 20-30% cheaper, with only a slight decrease in efficiency. I believe it gives them a price moat, although it may not be as robust as I would prefer. I believe that most solar panel companies have a switching moat, because buyers are unlikely to switch providers abruptly. This is especially true considering that solar panels usually come with a warranty of 10-12 years.
The CEO is Dr. Xiaohua "Shawn" Qu. He is not only the CEO but also the founder of the company. If you have read my previous analyses, you would know that I prefer it when the founder holds the position of CEO as well. In general, this means that the CEO is more interested in growing the company than in filling his own wallet. He has a BSc in Applied Physics from Tsinghua University in Beijing, an MSc in Physics from the University of Manitoba, and a PhD in Materials Science from the University of Toronto. Prior to founding Canadian Solar, he worked on a solar power project at Ontario Power Generation. Once he founded Canadian Solar, he did not expect it to become a multi-billion-dollar company. His initial goal was simply to work in a small company focused on renewable energy, which he believed would benefit humanity. He also wanted to provide for his family. It all changed when he won the contract for a solar device that would keep car batteries charged while vehicles were parked at outdoor parking lots at Volkswagen's Mexican operation. He has demonstrated his exceptional management skills by successfully guiding Canadian Solar through the challenges that arose during the financial crisis. This involved managing the decrease in European subsidies, which resulted in a drop in panel prices and the subsequent failure of both major and minor players in the solar panel industry. Dr. Qu is known to be very low-key, modest, unassuming, but extremely deliberate and intelligent. It is said that his success hasn't changed him much, but he himself has acknowledged that he has become less anxious about the business since he has delegated a lot of the day-to-day work to his management team.
I have determined that Canadian Solar has a pricing and switching moat, although it may not be as significant as we would prefer. I really like the management as well. Now, let us investigate the numbers to see if Canadian Solar meets our criteria for a strong moat. In case you want an explanation about what the numbers represent, you can refer to "MY STRATEGY" on the website.
The first number we will look into is the return on invested capital, also known as ROIC. I would like to see a 10-year history with growth rates exceeding 10% in all the years. Hence, it is safe to say that the numbers are disappointing, with only two years above 10%. However, it is not unusual for companies in the sector to have an underwhelming or negative Return on Invested Capital (ROIC). It should be something that changes as the industry evolves. Despite this, the return on invested capital (ROIC) is disappointing. The only positive aspect to mention is that the Return on Invested Capital (ROIC) has remained positive over the past decade, which can be considered an achievement in the industry.
The following numbers represent the sum of the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are a textbook example of how you would like to see a company growing its equity, as it has increased every year in the past ten years. It is also worth noting that year-over-year growth increased significantly in 2023 and reached a level that has not been seen since 2014. I'm very encouraged by these numbers. Hopefully, it is a trend that will continue.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Once again, the numbers are not particularly encouraging. They only had a few years of positive free cash flow. However, it isn't unusual for the sector to have negative free cash flow, so Canadian Solar isn't an outlier. In 2023, there was a significant increase in capital expenditures, rising from $628 million in 2022 to $1,3 billion in 2023. Levered free cash flow margin is negative in most years, which is not unusual for the sector. Free cash flow yield is also negative in most years, which does not provide much insight into valuation. However, valuation is a topic we will revisit later in the analysis.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a period of 3 years. We do this by dividing the total long-term debt by current earnings. Upon calculating Canadian Solar's financials, it is evident that the company has 6,04 years of earnings in debt, significantly exceeding the desired threshold of 3 years. This increase is attributed to Canadian Solar's investments in new factories. I would like to see management prioritize paying off debt in the future.
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Canadian Solar, like all other companies, also faces certain risks. One significant risk is higher interest rates. High interest rates are particularly detrimental to solar companies, as aptly described by the Motley Fool: "In solar projects, there is a significant initial cost that usually necessitates debt financing, followed by modest revenue streams over the next 20 years or longer." At the end of the installation's useful life, the solar panels no longer have value. Rising interest rates cause the value of long-term cash flows to decrease because investors use a higher discount rate to evaluate them. Higher interest rates could potentially decrease the number of solar projects that secure financing or make it challenging for Canadian Solar's customers to obtain the necessary funding to develop, construct, purchase, or install a photovoltaic (PV) solar power system on favorable terms, or even altogether. Global oversupply. The continuation of Chinese subsidization and dumping practices has led to a significant collapse in cell and module pricing. Meyer Burger, a European manufacturer of modules and cells, has announced that deteriorating market conditions in Europe have prompted them to prepare for shutting down module assembly in Germany. In India, a sudden and significant reduction in cell pricing in the non-domestic content market segment has weakened the effectiveness of the country's measures to tackle Chinese supply chain imports, leading to distorted market pricing in the country. Management has mentioned that they differentiate between industry overcapacity and oversupply, as not all capacity is truly effective. They expect that the market will undergo further normalization and consolidation, which is anticipated to lead to price increases in the second half of 2024. Nonetheless, global oversupply has resulted in a significant decrease in cell and module pricing, which has also affected Canadian Solar. The company experienced a decrease in shipments of solar modules in 2023 for the first time in three years as they reduced volumes to protect margins. One last risk is if governments reduce or eliminate subsidies and economic incentives for solar energy. In its annual report, Canadian Solar mentions that governments may revise, reduce, or eliminate incentives and policy support schemes for solar and battery energy storage power, which could cause demand for their products to decline. Canadian Solar also mentions that historically, the market for solar power has largely depended on the availability and size of government subsidy programs and economic incentives. Canadian Solar mentions that government mandates and economic incentives in many markets have either been reduced or are scheduled to be eliminated altogether. It is likely that eventually, incentives for solar and alternative energy technologies will be phased out completely. Furthermore, these government mandates and economic incentives can also disappear abruptly, as they did during the financial crisis in 2008, which had a negative impact on the performance of Canadian Solar.
It isn't all bad, and there is also plenty of potential for Canadian Solar. Increasing demand for their products. Management has mentioned that there are many trends, from data centers to electric vehicles to cryptocurrency mining, that will increase the demand for their products. According to BCG, the data center's share of U.S. electricity is projected to triple from 2,5% in 2022 to 7,5% by 2030. Moreover, the intensive requirements of these buildings, which must operate day and night, necessitate a mix of power generation sources, including solar and battery energy storage. Transportation is also driving a significant increase in electricity demand. Light-duty vehicles are expected to consume more than 30 times as much electricity by 2030, according to data from Princeton University. Furthermore, according to the International Energy Agency, data centers and transmission networks currently consume 1,5% of the world's energy. Combined, they emit roughly the same amount of carbon dioxide as Brazil does every year. The research in artificial intelligence technology poses a significant challenge to climate targets, as the energy required to train a single AI model surpasses that of 100 households annually. Electrification across these industries is driving significant energy consumption requirements. And electrification can only serve as an effective solution for decarbonization when it is coupled with a significant expansion of renewable energy sources. Recurring Energy. Canadian Solar's Recurrent Energy has become one of the world's largest and most geographically diverse project developers. BlackRock has recently made a $500 million investment in Canadian Solar's Recurrent Energy, which represents 20% of the business. This investment from BlackRock is instrumental in Canadian Solar's transition from solely a developer to a developer plus long-term owner and operator in specific markets. This transition enables a more diversified portfolio and stable long-term earnings. By owning these assets, Canadian Solar can retain more of the value they create during the development process, thus enjoying very stable cash flows. Management has mentioned that they are generating significant recurring revenue by undertaking these projects. The company expects to start seeing a significant revenue contribution from Recurring Energy in 2025-2026. This projection is supported by the business's gross profit margin of 41%, which is notably higher than the overall gross profit margin of 17%. Battery storage. Management has mentioned that battery storage plays a critical role in ensuring the dispatchability, stability, and security of solar energy. The battery storage market is projected to grow significantly, surpassing 1 terawatt-hour in cumulative capacity by 2030. Management believes that Canadian Solar is well-positioned to capture growth. Management also mentioned that since the day e-STORAGE began operations, every project has significantly contributed to profitability. After a softer year in 2023, when Canadian Solar transitioned to fully self-manufactured products, management is looking forward to a blockbuster 2024. Management expects that in the first quarter of 2024, e-STORAGE will deliver nearly as much as the entirety of 2023. Over the remainder of 2024, they expect e-STORAGE to gradually grow throughout the quarters, with Q4 almost doubling Q1. Management expects battery storage to significantly contribute to both Canadian Solar's revenue and profitability. Management also mentioned that the gross margin for e-STORAGE is around 20%, which is higher than the overall gross profit margin.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators for free.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 3,87, which is from the year 2023. I have selected a projected future EPS growth rate of 9%. Finbox expects EPS to grow by 9,2% in the next five years. Additionally, I have selected a projected future P/E ratio of 18, which is double the growth rate. This decision is based on Canadian Solar's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $40,76 We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Canadian Solar at a price of $20,38 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 890, and capital expenditures were 1.312. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 918 in our calculations. The tax provision was 60. We have 66,159 outstanding shares. Hence, the calculation will be as follows: (890 – 918 + 60) / 66,159 x 10 = $4,84 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. However, since Canadian Solar had a negative free cash flow in 2023, I am unable to make this calculation.
I believe that Canadian Solar has great potential due to its excellent management and the sector in which it operates. The historical numbers are mostly underwhelming, but this applies to all the companies in the sector that I have investigated. If you invest in a company in this sector, it should be for future growth. Like any other company in the sector, Canadian Solar has experienced some challenges in the last couple of years due to macroeconomic factors such as higher interest rates. At the same time, there has been a global oversupply of solar modules, leading to a significant decline in prices. Therefore, management has decided to decrease the volume to maintain their margins. The industry still depends on government subsidy programs and economic incentives. If these government mandates and economic incentives are reduced or eliminated, it would affect the entire industry, including Canadian Solar. Nonetheless, Canadian Solar is operating in a market where many trends will increase the demand for its products. Thus, there should be plenty of room for Canadian Solar and its competitors to grow. With the investment from BlackRock, Canadian Solar can retain more of the value they create in their Recurring Energy business, which means that Canadian Solar will enjoy very stable recurring cash flows moving forward. Finally, Canadian Solar expects rapid growth in its battery storage business, with management anticipating a significant contribution from battery storage to both Canadian Solar's revenue and profitability. Management has also discussed the potential of spinning off its battery storage business. I believe that Canadian Solar is one of the best companies in the industry and a good option for long-term investors if the shares can be bought below the Margin of Safety price of $20.
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