Will the Sun shine on Canadian Solar?
Opdateret: 21. nov. 2022
Like many others, I believe that renewable energy is the future. Lately, we have seen energy prices spike all over the world and Governments will need to invest in the transition to green energy. It doesn't mean that all companies in the sector will do fine though. In this analysis I will investigate Canadian Solar, and hopefully you get some inspiration to investigate it yourself as well.
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 keep as unbiased as possible. If you would like to see or copy my portfolio, you can read how to access it here.
Canadian Solar is a company that manufacture solar modules for residential and commercial systems and runs large scale solar projects. They also have a relatively new battery storage division. The company was founded in in Canada in 2001 and has subsidiaries in more than 24 countries on 6 continents. They are also cooperating with both Ikea and Amazon, where their solar panels are used on their warehouses around the globe. I have been looking into what distinguish Canadian Solar from other manufactures to determine if the company have a moat. I have come to learn that Canadian Solar is often considered the best value for money. Their panels are less efficient than the most efficient solar panels, however they are 20-30 % cheaper for only a small drop in efficiency. I believe it gives them a price moat, even though it isn't as strong as I would like it to be. I guess all solar panel companies also have a switching moat, as I believe most buyers are not going to switch providers suddenly, especially not when solar panels usually come with 10-12 years warranty.
Their 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 like when the founder is also the CEO. In general, that means that the CEO is more interested in growing the company than his own wallet. He has a BSc in applied physics from Tsinghua University in Beijing, a MSc in physics from the University of Manitoba and a PhD in material 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 didn't expect it to be a multi-billion-dollar company, he just wanted to work in a small company with renewables that he thought would be good for human beings, and he just wanted to be able to feed his family. It all changed though, as he won the contract for a solar device that would keep car batteries charged when vehicles were sitting at outdoor parking lots at Volkswagen's Mexican operation. He has shown his great management skills, as he navigated Canadian Solar through the issues that tailed the Financial Crisis, which resulted in cuts in European subsidies that ended pushing panel prices down and made both large and small players in the solar panel sector collapse. Dr. Qu is known to be very low key, modest, unassuming but extremely deliberate and very intelligent. It is said that his success hasn't changed him much but he himself has acknowledged that he has gotten 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 price and switching moat, even though they are not as large as we would like them to be. I really like the management as well. Now let us investigate the numbers to see, if Canadian Solar does live up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will look into is the return on investment capital, also known as ROIC. I would like to see 10 years of history with numbers above 10 % in all the years. Hence, it is safe to say that the numbers disappoints as they have one year above the 10 %. However, it isn't unusual for companies in the sector to an underwhelming or negative ROIC. It should be something that should change as the industry evolves. Nevertheless, the ROIC is disappointing and the only positive thing to say is that ROIC has been positive since 2013, which is somewhat of an achievement in the industry.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. The numbers are very encouraging, as Canadian Solar is growing year over year ever since 2013. As Canadian Solar currently has 64,269 shares outstanding, their book value per share is just around $28. And if the trend continues, it should be higher moving forward.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Once again, the numbers are not exactly encouraging. They only had a few years with 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. Hopefully, it will change moving forward so Canadian Solar will be free cash flow positive. The management has taken some steps to do so, which I will get into later in the analysis.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years. We do so by dividing the total long-term debt by current earnings. Doing the calculation on Canadian Solar, I can see that Canadian Solar has 7,86 years earnings in debt, which is way above the 3 years that we would want. Debt has increased year over year, which isn't something I like to see. I would like to see management pay off some debt this year. The high debt is a concern and something you need to consider if you want to buy stocks in Canadian solar.
Like all other companies, Canadian Solar has some risks as well. One way to investigate their risks are to read their annual report, where every company list a whole lot of different risks. I don't want to mention all of them here but the two that caught my eye were the following. One of the risks is that they are operating in a very competitive market, where the slightest dint in their reputation could be catastrophic, as many competitors are mirroring the same business model. Another risk factor, and one they mention in their annual report is if Governments reduce or eliminate subsidies and economic incentives for solar energy, which happened during the financial crisis in 2008. Another risk is freight and commodity prices. In the first quarter earning call management mentioned how higher freight prices combined with the price of polysilicon have decreased margins. In the current macroeconomic environment, these prices could continue to be elevated for some time. Higher interest rates a bad for renewables. Renewable companies are very capital-intensive, meaning that higher interest rates would increase the electricity costs for renewable energy companies. It should be mentioned though that according to a study by ETH Zürich and the Postdam Institute for Climate Impact Research, higher interest rates will hurt wind power projects worse than solar power project.
It isn't all bad and there are also plenty of potential for Canadian Solar. The industry is expected to grow at a fast pace. A report made by the Allied Market Research believes that the solar energy market will reach a value of $223,3 billion in 2026, which would be a compound annual growth rate of 20,5 %. Battery storage. The battery storage segment is still new for Canadian Solar, but it is growing nicely. In 2021 their battery storage shipments were 0,9 GWh, and management guided that it would reach 1,8 - 1,9 GWh in 2022 as they are entering new markets such as China and the UK. Higher degree of vertical integration. In the first quarter of 2022 earnings call management mentioned that they will switch from a pyramid structure to a trapezoid structure. It should result in a higher degree of vertical integration, which should result in better cost control and hopefully positive free cash flow. The reason management decided to that now is that they believe the sector has reached a scale of sustainable growth, which is another bullish sign on the solar sector.
All right, we have gone through the numbers, potential and risk regarding Canadian Solar, and now it is time for us to calculate a price for Canadian Solar. To calculate a price, we will need the numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 2 which is a bit lower than 2020, 2019, and 2018 but a little higher than 2021. I chose an Estimated future EPS growth rate of 15 (even though the solar energy market is expected to grow with 20,5 %, 15 % is the highest I use), Estimated future PE 30 (which the double of the growth rate) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY" we come up with the sticker price (some call it fair value or intrinsic value) of $60 and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Canadian Solar at price of $30 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". However, Canadian Solar had a negative operating cash flow in 2021. Hence, it is not possible to make the calculation
The last calculation is the PAYBACK time. I also described in "MY STRATEGY". But with the Free Cash Flow Per Share being negative in 2021, I can't make the calculation.
I believe that Canadian Solar has potential due to their great management and expected growth in the sector they operate in. The historical numbers are mostly underwhelming but it goes for all the companies in the sector that I have investigated. If you invest in company in this sector, it should be for future growth. I'm a bit concerned about debt, which is only one of the reasons that keeps me from increasing the position. Hopefully, their new structure would lead to cost control, which would leave to positive free cash flow that they will use to pay off some debt. I really like their focus on battery storage and the business is growing nicely, albeit it is still a small business. I believe Canadian Solar is cheap if you can get it below the margin of safety price at $30. Else you could wait until it trades below its current book value of $28. It is an investment in the future though, so don't expect fast returns.
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