Canadian Solar: Beneficial and Undervalued Directions (NASDAQ:CSIQ)
Canadian Solar (NASDAQ: CSIQ) operates in a growing industry, which many governments around the world intend to promote now. The management also gave very beneficial guidance for the year 2022. In my opinion, if the company’s battery storage evolves as promised by management, free cash flow will likely be skewed north. Using very conservative figures, the company’s fair price seems significantly higher than the current price.
Founded in 2001, Canadian Solar manufactures photovoltaic solar modules and manages large-scale solar projects.
With massive investments in the global solar industry, in my opinion, now is the perfect time to take a look at the solar panel manufacturer. If we also add the most recent commentary from management, Canadian Solar becomes even more interesting. Management noted double-digit sales growth and double-digit gross profit margin, and presented itself as one of the world’s top 5 module manufacturers. In my opinion, if management succeeds in coming up with more innovation, free cash flow will likely move north:
We ended 2021 on a high note, with revenue growth of 47% year over year and a gross margin of nearly 20% in the fourth quarter. Over the past decade, we have consistently been one of the world’s top 5 module manufacturers and have pioneered numerous solar crystalline PV technology advancements as well as business model innovations. Source: 10-Q
Management is also investing in other fast growing business models to further drive growth. Keep in mind that the company expects its battery storage business to deliver twice as many MWh as in 2022:
This includes our fast-growing battery storage business, where we delivered nearly 900 MWh in our first year of launch, and which we expect to double in 2022. Although we continue to manage challenging market conditions, we remain focused on leveraging the competitive advantages of our integrated business model to create greater long-term value for our shareholders. Source: 10-Q
Finally, management mentioned that obtaining recurring revenue is one of the main strategies of the company. The following words will probably be music to most investors’ ears. If recurring revenue is reported, management will likely be able to sell more shares in its announced IPO in China:
Our goal remains to grow our recurring revenue base from both retained assets and contractual services. Source: 10-Q
With recent advice, in my opinion, the implied price is $72
Canadian Solar gave fantastic directions for 2022, which is why I am starting my research on the company. Management reported a 45% increase in module shipments and 100% increase in battery storage shipments in 2022 y/y. Canadian Solar estimates it could achieve 35% sales growth in 2022.
I also noted that global annual solar installations could grow at a CAGR of 14% from 2022 to 2026. If we also assume a 35% CAGR in energy storage capacity additions, in my view, Canadian Solar really becomes a must-have stock:
I also expect a possible increase in subsidies from governments around the world. Canadian Solar, with over twenty years of experience in the industry, has acquired considerable expertise and know-how. In my opinion, it will be easy for the management to receive government subsidies and economic incentives.
Governments in some of our largest markets have expressed their intention to continue supporting various forms of “green” energy, including solar, as part of broader carbon reduction policies. The governments of many of our largest markets, including the United States, Japan and the European Union, continue to offer incentives for solar energy investments that will directly benefit the solar industry. We believe that near-term market growth is still largely dependent on the availability and magnitude of these government subsidies and economic incentives. Source: 20-E
With previous assumptions, I expect the CIS Solar business segment to bring in $9.7 billion in 2026. Additionally, the Global Energy business segment will likely grow from $1 billion in 2022 to around $2.1 billion in 2026. Note that my numbers are mostly tied to what I saw in 2021 and 2020.
I also assumed an EBITDA margin of 9% and a growing free cash flow margin from 2023 to 2026. Like other analysts, I have used a weighted average cost of capital of 5.43% with a cost of debt close to 9.26%, a cost of debt of 2.74% and a beta of 1.23. If we add the free cash flow from 2022 to 2026, the net present value should be $753 million.
Canadian Solar reports that there are peers trading at well over 8x EBITDA, which is more than the company’s current valuation. With this, I tried to be as conservative as possible and used an output multiple of 8x in this scenario:
I also assumed net debt of $1.606 billion, which includes the company’s convertible debt, long-term debt and Canadian Solar cash of $870 million:
Putting the previous figure together, I got a net worth of $5.08 billion and an implied stock price of $72.
Canadian Solar warned in the last annual report of a potential oversupply of solar energy products. As a result, suppliers and manufacturers like Canadian Solar could lower their prices, which could lead to lower sales and possibly lower free cash flow. In summary, as soon as equity researchers take notice, the company’s stock price could drop significantly:
Our business is affected by market and solar industry conditions. We believe that the solar power market and industry may experience oversupply from time to time. When this happens, many solar power project developers, solar system installers and solar power product distributors who purchase solar power products including solar modules from manufacturers like us may be affected. . Source: 20-E
Canadian Solar operates globally and generally changes the source of its revenues. This means that changes in tax structures and regulatory conditions are likely to occur in the future. Therefore, financial modeling can be a bit tricky. Our assumptions may not be correct if the effective tax increases:
Our sources of income have fluctuated a lot over the past few years. For example, in 2008, 89.5% of our revenues were attributable to Europe, while only 4.6% and 5.9% were attributable to the Americas and Asia and other regions, respectively. In 2020, Europe and other regions contributed 18.3% while the Americas contributed 35.1% and Asia 46.6% of our revenues. Source: 20-E
Canadian Solar could also be subject to class action lawsuits regarding its financial statements. Even if the claims are unproven, the company’s reputation may be tarnished, which may affect the valuation of Canadian Solar’s shares. Canadian Solar suffered a similar situation in 2009:
Our company and certain of our directors and officers have been named as defendants in class action lawsuits in the United States and Canada alleging that our financial disclosures in 2009 and early 2010 were false or misleading and in violation of U.S. federal tax laws. securities and Ontario securities laws, respectively. Source: 20-E
Based on previous assumptions, I included total net sales of nearly $10 billion in 2026 and a 2023 free cash flow margin of close to 2.3%. My results include free cash flow of $309 million for 2026, which is significantly lower than the previous scenario.
I also assumed a weighted average cost of capital of 10.5%, which implied a free cash flow sum close to $550 million.
With the results assumed in this scenario, the general sentiment towards the company could deteriorate. As a result, some investors may sell their holdings, so we cannot use the same exit multiple reported in the previous case scenario. With an exit multiple of 5.225x, the stock value should be close to $1.75 billion and the implied stock price would be $25.
Conclusion: the recent increase in assets is rather attractive
With $870 million in cash, nearly $7.5 billion in total assets and only $5 million in liabilities, in my opinion, the balance sheet looks healthy.
Given the growth of the solar industry and the total amount of net debt, I believe financial institutions will likely give more money to Canadian Solar if needed. I dislike the total amount of convertible notes and the fact that holders can increase the number of shares. However, in my opinion, if Canadian Solar succeeds in providing the expected free cash flow, the debts will be paid off:
Canadian Solar reports double-digit sales growth and double-digit gross profit margin in fast-growing solar industry. The guidance given for the year 2022 and the expectations until 2026 are quite attractive. In my opinion, with sufficient innovation, recurring revenue and cash flow from the new China IPO, Canadian Solar will likely be able to sell and manufacture many more solar panels. Additionally, if the battery storage business develops as expected, revenue growth may even exceed my expectations. I see some risk associated with the oversupply of solar energy products. However, the upside potential seems greater than the downside risk for Canadian Solar.