Investors are taught to look for a good company and buy its stock cheaply. Defining cheap is straightforward - it's a matter of how much you're paying for earnings, cash flow, dividends, book value, etc. But defining a good business is harder.
A good business has market power. The most attractive companies are increasing their power; less attractive firms are losing it.
By power, I mean a company's ability to impose its will on others. Can the company raise prices with impunity? Can it fire less profitable customers? Can it get concessions from suppliers? Or must it cave in to unreasonable demands?
A company with tremendous power is Apple. When the iPad came out, many customers waited all night for the device, yet there weren't enough to go around - perhaps by design. The power of exclusivity (there were no other tablet computers on the market yet), coupled with strong demand, meant Apple could keep customers waiting and charge high prices with impunity.
On the other side of the coin are powerless companies forced by their customers to degrade their business just to keep selling their product. A good example is the solar power industry and specifically SunPower Corp. of San Jose, Calif.
SunPower makes solar panels. It also makes systems incorporating the panels. Finally, it builds large-scale power projects that incorporate its panels and solar systems.
However, only the first of those operations - selling panels - is an attractive business with decent profit margins. Putting panels together in systems is a custom job, and so has lower margins.
Power projects are even worse. They force SunPower to finance large-scale construction and take on all the risks associated with project management, just for the sake of selling its panels.
Small wonder that while the company's revenue has grown fast over the past seven years, it has never had positive free cash flow. Meanwhile, its debt has ballooned, all because it allowed its business to degrade when pushed by customers.
An opposite view
Not everyone sees things this way. An analyst quoted in Barron's hailed SunPower's triple-pronged business as an example of vertical integration, and likes the company's strategy. I wonder what he would say if Intel started constructing server farms merely to sell its computer chips.
In my opinion, SunPower's large power projects are expensive favours to its customers, which is why the stock has been plunging for two years. Is it finally cheap? I don't think so, even though the company recently raised earnings guidance - but lowered revenue guidance.
Like Nortel toward the end, SunPower must finance its customers' purchases just to sell its wares. But since its own balance sheet can no longer handle the debt, it must go to others.
Recently it negotiated a loan of €200 million ($278-million) from two French banks to finance an Italian power project. But the loan is predicated on a slug of equity in the project being sold. It hasn't yet, and it must be, for the financing to go through.
Crude oil a key risk
SunPower also faces wider issues. The entire solar power industry depends heavily on government subsidies, which were put in place based on fears that oil is running out and alternative sources of energy are needed.
If oil's price ever declines, the solar businesses could suffer. Already, several European countries are expected to cut or cancel subsidies for solar power next year. Worse still, an oversupply of solar panels is looming, according to Credit Suisse.
Solar stocks have fallen recently as the bad news has become apparent to investors. SunPower's stock has declined less than others because of the optimism that still surrounds the company. But when an oversupply of solar panels meets undersupply of subsidies, the pressure to take on capital-hungry power projects just to sell panels may grow even more intense.
Investors should stay cautious on solar stocks as a whole, and on SunPower in particular. Lack of power over its business bodes a company's stock no good.Report Typo/Error
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