Evergreen: The Overlooked Solar Player
The market has pummeled solar stocks across the board in the recent downturn. Many of the big names in solar have lost over 50% during the past few months. All of this is in spite of the fact that the United States government recently extended and expanded the solar tax credit. There is also some optimism that Japan and potentially other nations will incentivize solar soon. Given this, it’s certainly arguable that there is a lot of value to be found in the solar sector and it may very well be worthwhile to bargain shop in solar stocks.
I recently mentioned a company called Evergreen Solar (ESLR) in my article “Seven Stock Ideas for the Impending Apocalypse.” I briefly touched upon some of the reasons one might want to buy into ESLR in that article; however, I wanted to do a more thorough write-up on it, as I believe it is one of the more overlooked solar stocks out there. Background
There are two major types of solar panel manufacturers: (1) thin-film and (2) polysilicon. First Solar (FSLR) and Energy Conversion Devices (ENER) are examples of thin-film manufacturers. Most of the other solar panel manufacturers use polysilicon. Evergreen fits into the latter camp, but they are somewhat unique in that they use a technology called “String Ribbon” to reduce the amount of crystalline silicon needed for their manufacturing process by about 50%. Since silicon is one of the most significant costs to producing solar panels, this means that Evergreen has potential to become the most cost-effective producer amongst the silicon group.
It remains to be seen if Evergreen can catch up to thin-film manufacturers. Nevertheless, silicon-based solar products have been more thoroughly studied than thin-film technologies which could breed a potential advantage in that more knowledge about these products could result in higher quality. Since purchasing solar panel requires huge up-front expenditures and it is expected that the investment will only pay itself off over time, it would make sense that consumers would be very concerned about product quality.
One trend I have noticed with solar investors is that most people are seeking out the lowest cost producers, or in essence, they want to find the Wal-Mart of solar companies. I would argue that given the nature of a solar energy investment, it might be wiser to search for the Honda of solar companies. Only time will tell whether thin film products hold up as well or better than the more traditional silicon-based panels, so I believe that while they have a (short-term?) cost advantage, there are some greater long-term risks with some of the newer technologies. This is one reason to believe that silicon-based manufacturers might be undervalued a bit. Business Plan
Until recently, Evergreen had a rather low manufacturing capacity of 15 MW. They recently opened a new facility in Devens, Massachusetts that has upped their yearly capacity by 80 MW. There are plans for further upgrades at Devens that will add on an additional 80 MW of yearly capacity (bringing the total to 160 MW for Devens) sometime around the end of 2009. Evergreen has plans to expand further beyond this and would like to increase their manufacturing capacity to around 620 MW by 2011 and 850 MW by 2012. Given the credit crunch, obtaining financing for those projects might be a little more difficult, but the company is hoping that things ease up a little bit in the next year so that they can make the upgrades.
The good news is that Evergreen has a nearly $3 billion backlog and they have sold most of their production through 2012, meaning there are not many worries about a lack of demand for their product. Additionally, as I outline below, I believe their model will start to show signs of success in the next year or so, which will make obtaining capital much easier.
It is important to note that Evergreen has a partnership (in the figurative, not legal sense) with a German-based solar manufacturer called EverQ. Evergreen shares their “String Ribbon” technology with EverQ and receives royalty payments from the company. ESLR also has an equity interest in EverQ. EverQ upgraded their manufacturing capacity a little bit ahead of ESLR and appears to be having a decent amount of success. The fact that Evergreen’s model has proven effective at its sister company is yet another reason for optimism in regards to ESLR’s prospects. Margins and Expenses
For the time being, perhaps Evergreen Solar is the type of company that only a cost accountant could love. When most investors look at their earnings on the Income Statement, they can’t help but to be disappointed with ESLR. Evergreen has, to date, never turned a noteworthy profit. Moreover, they released 3rd Quarter results recently that showed an 18 cent per share loss. However, it takes a much deeper look at Evergreen’s margins, financial position, and business plan to gain an understanding of their potential.
Evergreen’s gross margins have actually been fairly good and have only grown stronger over time. They operated with single digit gross margins for a few quarters in 2005 and 2006, before consistently producing gross margins upwards of 20% in 2007. By the 2nd quarter of 2008, they reported a 34.7% gross margin before their new facility’s initial production lines lowered that down to 5.7%.
Even the overall gross margins might be deceiving since some of their revenues are coming from royalties from their business ally, EverQ. If we ignore the royalty and fee revenues reported on ESLR’s income statements and only use product revenues, we end up with margins from Q1 and Q2 in 2008 of 42.3% and 43.6% respectively. All of this is important because it gives us some insight as to where ESLR’s profitability could eventually be headed.
That brings us to the next important element of ESLR’s income statement: operating expenses. The two major operating income items reported on their income statement are R&D and SG&A expenses. These charges are a bit more fixed in nature and have not increased as rapidly as their cost of revenues line item. In fact, R&D has stayed in a fairly consistent range since Q4 of 2006. The same has largely held true for SG&A, however, the opening of Evergreen’s new Devens facility has slightly increased that figure. While I expect that these expenses will increase some as Evergreen Solar grows, they will not increase nearly as quickly as the cost of revenues line item. This brings us to a major insight about Evergreen --- if production dramatically increases, profits should follow. Forecasting ESLR
While it is difficult to create accurate forecasts for a company going through as significant production changes as Evergreen, simply playing around with the numbers and attempting to create some possible forecasts can give us some insight about Evergreen’s potential.
First off, I constructed a two-year forecast spanning through the end of FY 2010. I assumed gross margin would be 25% in Q1 of 2009 (which might be a bit high) and would gradually increase to 40% by Q4, before dropping back down to 20% in Q1 of 2010 (as Devens II becomes operational) and then gradually increases back to 40% by the end of the year.
Revenues are $70 million for Q1 and gradually increase to $108 million by the end of ’09. By the end of ’10, they hit $198 million. I generated revenue projections by taking product revenues from Q2 of 2008 and multiplying by the factor that capacity was increased. For instance, ESLR had 15MW annual capacity originally, but added an additional 80 MW at Devens; I take this to mean, there is a total capacity of 95 MW (even if I’m wrong about this, it won’t make much difference in our later calculations). Thus, I multiply revenues by 6 in order to get a result. Since most of these projections seem extremely uncertain to me, I try to be reasonably conservative. I ignore royalty revenues completely since I have no information suggesting that line item will increase significantly over time (and it become more negligible as ESLR’s product revenues increase anyway).
I increase R&D and SG&A slightly over the two-year horizon until in Q4 of ’10, R&D equals $7.5 million and SG&A equals $9 million. Since I find it difficult to give their other operating expenses without precise guidance, I will ignore that particular item and simply compare the results to similar results from prior periods. Finally, I ignore equity income from EverQ despite the fact that this item would be somewhat significant. I also assume further dilution in the stock, particularly during 2010 (when I assume the market might be in better shape than at the present).
Hence, based on these rather conservative guidelines, I end up getting earnings per share of about 43 cents per share for FY ’09 and 62 cents per share for FY ’10. Other expenses would probably reduce that further, but remember I cut out equity income and royalty revenues, as well, which might offset that to an extent. It’s also worth noting that those figures are somewhat distorted as the profits were lowest during the ramp-up stages in Q1 of each respective year. For Q4 of 2010, I had EPS of 26 cents per share. The Ideal Quarter Method
It was difficult enough forecasting for two years forward so I decide to use what I term “the Ideal Quarter” method to try to ascertain Evergreen’s future potential five years down the road. With this method, I look at historical costs and margins and attempt to ascertain what an average quarter might potentially look like at a future time. Currently, ESLR has plans to expand capacity to around 620 MW by 2011 and 850 MW by 2012, so my goal is to get an understanding of their potential profitability at that point.
Based on the “ideal quarter”, I end up with results of $0.70 EPS once ESLR has a manufacturing capacity of 620 MW per year. I end up with $1.02 EPS for 850 MW of capacity. These projections assume ESLR sells all “authorized shares” of common stock. If we multiply these results by four (to extrapolate yearly results), we end up with $2.80 EPS for 620 MW and $4.08 EPS for 850. While, these estimates will probably end up being substantially off from the actual results, it does at least give us a clue as to ESLR’s potential and why there should be reason for some optimism for this stock. Even based on a rather low P/E of 10, that would seem to suggest that if things worked out well, this stock could have a ceiling around $40-45 by the beginning of 2013. The Balance Sheet and Cash Flows
What makes Evergreen particularly attractive right now is that they are selling below the book value of their equity interest, which is roughly equal to $4.30 per share. ESLR produced marginal positive cash flows from operations [CFOs] in Q2 of 2008 and should begin producing positive CFOs on a more permanent basis in FY ’09. Given their depreciation charges and high start-up costs, their cash flows will probably tend to be somewhat higher than their earnings, as well, for any periods where they are not ramping up manufacturing capacity. Hence, the current price of the stock (under $4) would seem to assume they are simply breaking-even over the long haul.
Other balance sheet indicators suggest Evergreen is in solid financial shape. Their total debt-to-value is about 40% and they have a working capital ratio of 5.3. Even discounting “restricted cash”, they have a quick ratio of 4.9. The Case for Evergreen Solar
This is a cheap stock with huge potential. The market has largely overlooked this company because they haven’t turned a profit yet, but the only reason they haven’t turned a profit is because operating expenses are eating away at their much more impressive gross margins. Once production is ramped up, this will no longer be the case and this company has very strong potential within the next 3 – 10 years.
Management gives the impression of being very forthcoming and honest. This is a US-based manufacturer, which means that those championing “energy independence” will find this company attractive. Unlike one of their major American competitors, First Solar, Evergreen does not rely on a rare Earth element (tellurium) to make its product. Evergreen uses higher quality silicon to produce its panels and there is more knowledge about silicon-based solar products than alternatives. All the same, Evergreen has developed technology that helps reduce the amount of silicon usage, thereby lowering costs. Evergreen also has an equity interest in a sister company, EverQ, which is using the same technologies and has already had some success manufacturing on a larger scale than Evergreen.
Overall, if things came together for this company, this stock could be priced in the $20-60 range five years from now. Even if they don’t achieve this high potential, will the company really be worth less than $3.50 per share? The Case against Evergreen Solar
Given the value of their equity, their massive backlog, their earnings and cash flow prospects, and other competitive advantages, there are a limited number of cases I can make against ESLR. However, there are three that come to mind.
Some have argued that solar power in general is doomed to failure. If this is the case, then Evergreen will probably tank with the rest of the bunch. However, I do not believe this is a very strong argument given the general public’s shift towards desiring alternative energy sources. Moreover, with all the solar incentive packages we are seeing from various governments and all the capital invested in solar companies, it has become apparent that there is widespread institutional support for solar power. This makes it seem unlikely that solar will fail completely at this stage.
A more convincing argument against ESLR might be that silicon-based solar manufacturers will lose out to other technologies and that companies like Nanosolar, First Solar, and others that will eventually crush Evergreen. I can’t see the future so there’s no way for me to refute this argument and must be considered a possibility. However, for the time being, there seems to be room for the various types of technologies and lower silicon prices should help make the silicon-based manufacturers more competitive in the long run. Additionally, there are legitimate reasons for consumers to prefer solar panels manufactured using silicon.
The final substantive argument I can make against ESLR is that due to the fact that many of their sales are in Euros, continued erosion in the value of the Euro versus the US Dollar (S) could harm their operating results. It is unclear to me, however, how significant this harm would be and it seems unlikely that this would be so detrimental, that it would offset the company’s current valuation. Conclusions
Evergreen appears to be a good bargain to me. Their current earnings create a distorted picture of their future potential. If their gross margins from their original 15 MW of capacity are any indication, they could have a very bright future ahead. I’ve also been consistently impressed with management and believe this company is more concerned about product quality than others. If nothing else, ESLR has impressed many of their customers given their massive backlog. In an industry as volatile as solar, there is always downside to every stock, but given the immense upside with Evergreen, it seems worthwhile to me.
This is not a stock I would recommend purchasing for the short-term. In fact, it’s possible that the price will decline even more through the end of this year. Evergreen’s guidance for the 4th Quarter of FY 2008 results in a loss of roughly 14 cents per share, so investors will likely punish the company even more once that time comes. This does seem to be a great long-term buy, however, and I would recommend being prepared to hold onto the stock for at least 2-3 years, if not longer.
I would set a 3-year target price for ESLR at $15 based on the information available to me. Upside potential in the next five years could range anywhere from $60 - $80 if impressive operating results are achieved and solar stocks are back en vogue again. Downside risk is that the stock drops all the way to $0.