Canadian Solar: Will the sun shine on them?
Opdateret: 23. aug.
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 well though. In this analysis, I will investigate Canadian Solar, and hopefully, you will 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 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 start your investment journey with as little as $50.
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 on 6 continents. North America is the largest market as it contributed 28% of revenue in 2022, followed by EMEA (26%), China (26%), Asia ex. China (11%), and Latin America (9%). Canadian Solar operates in two segments: CSI, which designs, develops, and manufactures solar ingots, wafers, cells, modules, and battery storage products. In 2022, CSI contributed approximately 89% of the revenue. The other segment is called Recurrent Energy, which develops utility-scale solar and energy storage projects. Recurrent energy contributed approximately 11% of revenue in 2022. They are also collaborating with both Ikea and Amazon, using their solar panels on warehouses worldwide. I have been looking into what distinguishes Canadian Solar from other manufacturers to determine 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 strong as I would prefer. I believe that most solar panel companies have a switching moat, as I don't think buyers are likely to switch providers abruptly, especially considering that solar panels typically come with a warranty of 10-12 years.
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 prefer it when the founder holds the position of CEO as well. In general, that 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 didn't 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, though, 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 included dealing with the reduction of European subsidies, which led to a decline in panel prices and the subsequent collapse 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 substantial as we would prefer. I really like the management too. Now let us investigate the numbers to see if Canadian Solar lives 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 invested capital, also known as ROIC. I would like to see a 10-year history with numbers above 10% in all the years. Hence, it is safe to say that the numbers disappoint as only one year above 10%. However, it isn't unusual for companies in the sector to have an underwhelming or negative ROIC. It should be something that changes as the industry evolves. Nevertheless, the return on invested capital (ROIC) is disappointing. The only positive aspect to mention is that 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 percentage growth year over year. 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. I'm very encouraged by these numbers. Hopefully, it is a trend that will continue.
Finally, we will investigate the free cash flow. In short, free cash flow refers to the cash that a company generates after it has covered its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use the margin to provide a clearer understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected 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. Hopefully, moving forward, Canadian Solar will continue to be free cash flow positive every year, as they managed to be in 2022. The management has taken some steps to achieve this, which I will discuss later in the analysis. I encountered some issues with the data related to the free cash flow yield. However, if you examine the free cash flow and leveraged free cash flow, you can gain an understanding of what the free cash flow yield might have been.
Another important aspect to consider is the level of debt, and it is crucial to determine whether a business has a 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. Doing the calculation on Canadian Solar, I can see that the company has 4,33 years of earnings in debt, which is higher than the desired threshold of 3 years. However, the debt-to-earnings ratio is the lowest we have seen in three years, but I would like to see management prioritize paying off more debt in the future. The high debt is slightly concerning and something you need to consider if you want to buy stocks in Canadian Solar.
Like all other companies, Canadian Solar also has some risks. One way to investigate their risks is to read their annual report, where every company lists a whole lot of different risks. I don't want to mention all of them here, but some of the risks that caught my eye were the following. One of the risks is that they are operating in a highly competitive market, where even a minor dent in their reputation could have catastrophic consequences, as many competitors are imitating the same business model. Another risk factor mentioned in their annual report is the reduction or elimination of subsidies and economic incentives for solar energy by governments. This occurred during the financial crisis in 2008 and had a negative impact on the performance of Canadian Solar. Nothing suggests that it will happen again, but given the economic headwinds we are currently facing, it is a possibility that could occur in the future. Another risk is the volatility of freight and commodity prices. We have observed increased freight prices in the past, which negatively impacted the profit margins of Canadian Solar. Freight prices have since decreased, but they could easily tick up again. Furthermore, Canadian Solar has experienced a decline in commodity prices, which has resulted in Canadian Solar needing to make an inventory write-down due to the sharp decline in material costs. The sharp decline in material costs means that customers will pay less for the end products, resulting in the need for Canadian Solar to write down inventory. Higher interest rates are bad for renewables. Renewable energy companies are highly capital-intensive, which means that higher interest rates would result in increased electricity costs for these companies. It should be mentioned, though, that according to a study by ETH Zürich and the Potsdam Institute for Climate Impact Research, higher interest rates will have a more detrimental impact on wind power projects compared to solar power projects.
It isn't all bad, and there is also plenty of potential for Canadian Solar. The industry is expected to grow rapidly. A report by Allied Market Research predicts that the solar energy market will reach a value of $300,3 billion in 2032, indicating a compound annual growth rate of 12,3%. The recurrent energy segment. Canadian Solar has decided to change its approach in this segment, opting not to immediately monetize these projects by selling them once they are completed. Instead, Canadian Solar aims to maintain long-term ownership and operation of these projects, which is expected to result in capturing a higher value from them. The segment has a significant pipeline, with 25 gigawatts of solar projects and 52 gigawatt hours of battery storage projects in development. It is a much higher margin business, delivering a gross profit margin of 36% in 2022 compared to 18,5% in the CSI segment. A higher degree of vertical integration. Canadian Solar is currently transitioning from a pyramid structure to a trapezoidal structure. It should lead to a higher level of vertical integration, which in turn should result in improved cost control and, hopefully, positive free cash flow. The reason management decided to do that now is because they believe the sector has reached a sustainable level of growth, which is another positive sign for the solar industry.
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 of 3,37, which is from 2022. I have chosen an estimated future EPS growth rate of 12%, which is in line with the expected growth of the solar sector. The estimated future PE is 24, which is double the growth rate. Additionally, we already have the minimum acceptable return rate of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $62,09. 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 $31,05 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 917, and capital expenditures were 628. I attempted to review their annual report to determine the percentage of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 440 in our calculations. The tax provision was 107. We have 64,506 outstanding shares. Hence, the calculation will be as follows: (917 – 440 + 107) / 64,506 x 10 = $90,53 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Canadian Solar's Free Cash Flow Per Share at $4,49 and a growth rate of 12%, if you want to recoup your investment in 8 years, the Payback Time price is $61,85.
I believe that Canadian Solar has great potential due to their excellent management and the sector they operate in. 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 the rest of the industry, Canadian Solar is facing some short-term headwinds due to the decline in material costs and high interest rates. However, these issues are expected to be temporary. A long-term risk for Canadian Solar is the competitive nature of the market. However, the company does have some advantages, such as having been in business for more than two decades and offering cheaper solutions. I appreciate Canadian Solar's decision to transition its recurrent energy segment from selling off projects to becoming the long-term owner and operator. It may hurt profits in the short term but should increase profits in the long term. I also like that Canadian Solar operates in a sector that has long-term tailwinds despite the short-term headwinds. Canadian Solar is currently trading below all three calculations, indicating that the stock is undervalued. Furthermore, as I write this, Canadian Solar is trading below its book value of $37,87 per share. I believe that buying Canadian Solar below the margin of safety price at $31,05 is a good investment, and I just increased my position.
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