As in a late Ontario fall, the clouds have rolled in and the skies are grey for Canadian Solar Inc.
Some of this, one can say, is of the company's own making: Canadian Solar's blowout third-quarter earnings report this week included what investors saw as disappointing guidance for sales and profit margins in the current three months.
Much is out of its control: As oil prices have tanked, most solar-energy stocks have followed, on the premise that cheaper fossil fuels make solar less necessary.
The end result: Guelph, Ont.-based Canadian Solar has lost all the gains it posted since an August earnings surprise launched the shares on a path from $25 (U.S.) to more than $41 in early September. The shares lost 18 per cent of their value from Tuesday to Thursday before rebounding 4.7 per cent Friday to close at $26.93.
Even more striking for investors: The stock's decline, coupled with sharply increasing earnings, have created a remarkable reversal in its price-to-earnings ratio. Earlier this year, Canadian Solar traded as high as 62 times its trailing earnings, per Standard & Poor's Capital IQ, and spent much of the first half of the year above 40. Now, the stock trades at just under nine times trailing earnings – and has a forward P/E of less than six, when analysts' estimates are taken into account.
All told, it represents an opportunity for solar bulls who believe the sun will come out – perhaps not tomorrow, but in the long term.
"Canadian Solar is trading at … a discount to growth, and a discount to its peer group … unjustified, in our view," Paul Coster, an analyst for JPMorgan, wrote Wednesday after the company announced earnings. He has an "overweight" rating and a $38 target price. "The selloff in the stock seems unjustified, based on these solid 3Q results and the broader narrative."
The broader narrative, of course, is the future of the photovoltaic solar industry, and Canadian Solar's place in it. The company started primarily as a seller of solar modules, which has increasingly become a lower-margin business. Recognizing that, the company has begun offering higher-margin "total solutions" – i.e., building the solar-power generations systems or offering engineering and construction services to others. Canadian Solar is on track to book 50 per cent of its revenue in 2014 from "total solutions," versus just 11.5 per cent in 2012.
The focus on margins is at the heart of Wednesday's disappointment. Canadian Solar posted revenue of $914-million, versus analyst consensus of $803-million, and earnings per share of $1.73 versus $1.16, says analyst Josh Baribeau of Canaccord Genuity Inc. Gross margins of 23 per cent were well above the high-teens numbers of the second quarter.
The company's guidance for the fourth quarter, however, was for revenue in a range below the analyst consensus, and gross margins sliding back to the high teens of the second quarter.
Mr. Baribeau argues that the consensus was unduly inflated by one outlying estimate, and the gross margin pressure should not have come as a surprise. Five large, higher-margin Canadian project sales, totalling $300-million (Canadian), drove the third-quarter results, he says, and upcoming projects have lower margins.
"We do not view Canadian Solar as a margin-expansion story, but rather as more of a solid top-line grower with strong operating leverage and cash earnings," says Mr. Baribeau, who has a "buy" rating and $46 (U.S.) target price. While 72 per cent of the quarter's sales came in the Americas, versus 21 per cent in Asia and 7 per cent in Europe, "We believe that the company can increasingly lever its experience in large-scale project origination, underwriting and execution learned in Canada to deliver projects [in] other markets."
Chris Damas, an analyst and editor of BCMI Report, was buying Canadian Solar shares Wednesday as they fell below $30. "I cannot stress this enough – solar has come of age, and after over 12 years of following the sector, the number of players has been whinnied down to large, sophisticated and well-capitalized players of which Canadian Solar is one of the best, if not the best, name."
He also adds that Canadian Solar "is a volatile stock and is for risk-tolerant investors," which is certainly true, given the roller-coaster ride it has taken its shareholders on. Solar power still relies on government subsidies; policies can change as political power shifts and declining oil prices make alternative energy seem less urgent. (The outlook for U.S. solar power must be said to be less robust after that country's recent elections.)
One of Canadian Solar's chief challenges will be to build on its Ontario successes, even if the new projects are less lucrative; Axiom Capital Management Inc. analyst Gordon Johnson believes the company cannot come close to replacing the high-margin Ontario sales. Per an article in the investing newspaper Barron's, Mr. Johnson believes the company's "earnings are about to collapse," and he names it his top short-selling idea in the solar space.
Strong stuff, indeed, and a view worth considering. The sell-side analysts like Mr. Baribeau of Canaccord would counter that Canadian Solar's overall project pipeline continues to grow despite all the Ontario-based revenue recognized in the third quarter. "While the new pipeline carries increased policy risk and in some cases lower margins compared to the Canadian projects that have been the company's mainstay thus far, we still have confidence that the company is among the best-positioned solar companies approaching these new markets and can complete this strategy given its solid track record of execution."
Any investor with a similarly sunny outlook for the solar industry is advised to look past Canadian Solar's current grey days.