Dear readers,
Canadian Solar (NASDAQ:CSIQ) is a Canadian-based global solar power company which manufactures solar panels and energy storage solutions. It operates in a highly cyclical sector and produces highly commoditized products, which tend to result in volatile swings in the share price.
The cyclicality stems from the fact that solar panels are all more or less the same with little competitive advantage, and their technology evolves quite rapidly. This requires a lot of cash flow to be reinvested into added capacity during the good times, which results in large output growth and stock price appreciation. This is exactly what happened to Canadian Solar in 2020 and 2021. But when interest rates rise above the expected energy savings from putting solar on a roof (3-5%), the market for solar panels quickly softens as no one is eager to invest in the technology. Consequently, inventory starts piling up and the stock price plummets, as it did in the case of Canadian Solar.
Investing in cyclical stocks can be very profitable, but the key is timing the cycle well. I was very cautious about the company last year, when the stock traded near its highs at $38 per share, and suggested that investors should wait for a pullback before jumping in.
Many, however, got caught up in the hype as evident from some comments in my previous articles, such as:
- The company is going gangbusters, FY23 is going to blow the doors off, wait for $31 if you want but am not sure you will get there.
- CSIQ is one of the clearest candidates to multibag over the next 6-24 months that I have seen in all my time in investing (about 20 years).
- You can't face a tailwind ;)
But you cannot fight cyclicality. As the price declined, I became increasingly bullish and started accumulating shares (though a small position). Most recently, in January, I published an update to my thesis and issued a BUY rating at $23 per share, calling the company Too Cheap To Ignore. By that point, the stock was trading at a significant margin of safety at only a fraction (35%) of the value of its holding in the publicly listed Chinese subsidiary CSI Solar Co.
Since then, results (incl. Q1 2024) have been unexciting, forward growth guidance has declined meaningfully (again), and the stock has continued on its downward trajectory and has underperformed the S&P 500 (SPX) by about 30%. The stock is now undervalued by any measure, but there are also reasons to be careful.
Financials, guidance, and outlook
The first quarter of 2024 marked a third consecutive quarter of quarter-over-quarter revenue declines, as revenue came in at just $1.33 Billion, despite a 630 bps expansion in the gross margin. This decline was entirely attributable to lower sold volume of solar panels caused by low overall demand for the technology. Earnings for the quarter were also largely unexciting at $0.19 per share, up from an extremely disappointing Q4, but significantly down from early 2023 levels.
As a result of mainly macroeconomic headwinds, management has once again lowered their forward guidance. Last time I wrote about Canadian Solar, four months ago, management was guiding towards 2024 solar panel shipments of 42-47 GW. Now, that number is down to 35-40 GW, a decline of 16%. And I would not be surprised to see this target reduced further it the headwinds persist.
As a result, consensus forward EPS estimates have adjusted and now stand at just $2.12 for 2024, representing a year-over-year decline of 45%! Beyond, this year, analysts are very optimistic and forecast a miraculous rise in earnings of 75% in 2025. But I have been around long enough to be very cautious in taking these expected U-turns two to three years from now at face value. Therefore, when determining whether to buy the stock or not, I am only going to look at 2024e expectations and ignore any growth beyond, which is highly speculative at this point.
Valuation
With 2024e EPS of $2.12, the stock trades at 9x forward earnings which is below the historical average of about 12x, despite the fact that we are now likely seeing trough earnings. This indicates that the stock may be undervalued, but given the cyclicality (which is clear from the poor fit of the blue line below to the actual stock price) I do not put too much emphasis on this measure.
A better indication of the margin of safety that we are getting is to look at the company as a sum of its parts. Canadian Solar owns a significant 62% stake in its Chinese subsidiary, which was recently spun-off, and now trades publicly under its own ticker. The subsidiary is called CSI Solar Co. and currently has a market cap of 46 Billion Yuan, which is just under $7 Billion. We can calculate that CSIQ's ownership stake in the Chinese subsidiary alone is worth $4 Billion. Compare this to CSIQ's market cap of $1.2 Billion, and it becomes clear just how cheap the stock has got.
Canadian Solar stock could 3x, and it would still trade at a discount to the value of its holding in the Chinese subsidiary, completely ignoring any value of the rest of its business which generates Billions in solar panel sales every year. This leads me to believe that the stock is extremely undervalue here and as a result, I reiterate my Speculative BUY rating for the stock. The reason it's speculative is that there are some potentially pretty significant risks to consider.
Risks
The way I see things, Canadian Solar faces three distinct risks.
First, a slowdown in demand for solar panels. This risk has already materialized to a large extent, but things can certainly get worse if (1) interest rates stay higher for longer making energy savings from the installation of solar panels uninteresting relative to treasury yields, or (2) if the economy falls into a recession and people start saving on everything non-essential, including improvements to their homes.
Second, there is the China risk to consider. Despite what the company name would have you believe, Canadian Solar is basically a Chinese company. They manufacture the majority of their products in China and the management team is also, to a large extent, Chinese. This brings lack of transparency and a number of potential risks that are hard to quantify, but are certainly worth considering.
Third, company ownership is very concentrated at the top, as the CEO (Dr. Shawn) owns 20% of the business. While this can help align management and shareholder interests, it also introduces the risk of taking the company private. Dr. Shawn has already tried this in 2017 at $17 per share and although the board did not approve it back then, there is no guarantee that the company cannot be taken private from under current investors.
Bottom Line
There are substantial risks to investing in Canadian Solar, but I believe that the current price justifies these risks. As a result, I continue to very slowly accumulate a small position, which I intend to hold until the next cycle. I reiterate my Spec BUY rating here at $19 per share.
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