Magic Formula Stock Review: GT Solar (SOLR)
Solar is a solar equipment manufacturer and service provider. The company has two main products, and a business unit built around each of them. The Photovoltaic business (76% of fiscal 2009 revenues) makes and sells direct solidification systems, or DSS units. A DSS unit is a furnace specifically designed to melt silicon to produce the ingots used to produce wafers on which solar cells can be constructed. The sale of these units alone accounted for 2/3rds of revenue over the past 12 months. The Polysilicon business (24%) makes and cells chemical vapor deposition, or CVD, reactors. CVD reactors are used to manufacture polysilicon, the raw material needed for solar panel and semiconductor construction. GT Solar collects the vast majority of sales (91%) from customers in Asia, including China. The company was IPO'd last July at a price of $16.50... way above its current stock price of about $6 a share.
Most everyone realizes the growth potential in solar. 2008's soaring gas and energy prices ignited yet another push for renewable and sustainable energy sources, and new President Obama has made renewable energy credits a prime feature of his stimulus and budget plans. The overall solar market had been growing at a 35% annual pace before last fall's market meltdown, and an even faster 60% pace in the United States (although from a small base). GT Solar has fully benefited from this, growing revenues 122% last year and 306% in 2007! Although revenues are forecast to be slightly down for 2010 due to economic weakness and difficult credit, an improvement in economic conditions could lead to resumed growth in this exciting market.
GT entered the CVD business in 2007 in response to the worldwide shortage of polysilicon. Historically, a small number of wafer makers (including MFI stock MEMC Electronic Materials, ticker WFR) controlled the market for silicon, with rather high barriers to entry due to a dearth of available equipment for entering the business. GT Solar looked to stimulate the entry market by providing CVD reactors, a key piece of equipment, in turn creating competition to lower the prices for silicon, which comes full circle to stimulate solar demand due to lower prices (in turn juicing demand for DSS units).
Given this kind of growth potential, GT Solar is priced quite low at a 17% earnings yield. Weak customer demand due to credit constraints and and high prices (solar is very expensive and more difficult to justify in a difficult times) has led to a 2010 revenue guidance of 8% lower than 2009. However, the forward earnings yield is still 11% - a nice number given the longer term growth prospects here. Also, GT Solar is financially sound. The balance sheet shows $107 million in cash vs. no debt. Owing to GT's position as one of only a few DSS and CVD manufacturers, return on capital is outstanding on both a traditional (82%) and MFI (240%) basis. Free cash flow margin for the first 9 months of fiscal 2009 was a stellar 25%. GT's backlog at the end of March stood at $1.18 billion, and since the company requires deposits of up to 40% (with letters of credit for the rest), we can have reasonable confidence in collection of those orders.
Given these facts, GT Solar could make an exciting choice for the MFI investor. However, there are numerous risks and unpredictabilities that prevent me from selecting the stock as a MagicDiligence Top Buy pick. Customer concentration is a major one - GT Solar generates over 80% of sales from just 4 customers. The loss of any one of them would dramatically affect sales. And losing one would not be unprecedented, as former major customer LDK Solar switched to a competitor last year. On the other side of the coin, GT relies on just a handful of small suppliers for components. If these suppliers were unable to scale with GT's growth, or were to face financial difficulties, finding replacement suppliers will be difficult.
Also, the way that ownership is structured is less than attractive for a common shareholder. The operating units are held under GT Holdings, which is owned by a couple of investment firms. They spun off about 25% to the public, solely to pay themselves - the IPO money was not used to clean up the balance sheet or provide dry powder for growth as is usually the case. The investment firms still control 75% of the company, which means that common shareholders have little say in decisions.
Finally, solar in general is just an unpredictable market, with lots of moving parts and evolving technologies. It remains significantly more expensive than both traditional energy sources and alternative "clean" energy sources like wind - demand for solar is almost solely driven by government credits which can be changed or eliminated at any time. Even inside of the solar market there are alternative technologies, such as "thin film" processes which are cheaper (currently) and more flexible than the traditional polysilicon cells serviced by GT. Demand for CVD machines is dependent on continuing shortages of polysilicon, which may or may not continue. Warren Buffett would file GT Solar under the "too difficult to predict" category and move on.
Adventurous MFI investors might want to take a look at GT Solar - if it can regain past growth the stock is clearly a bargain, and financially strong. But more conservative investors might want to take a pass as the future is quite cloudy on this stock.
Steve owns no position in any stocks discussed in this article.