This article is part of our Rising Star Portfolios series.
What do you call it when the market rewards your 143% year-over-year growth in annual revenue and very handily turning a loss last year into a profit this year, along with guidance of 80% revenue growth for the upcoming year, with a 21% shellacking of your stock price? I don't know about you, but I call it a chance to pick up some more shares.
Power-One reported earnings for the fourth quarter and full year late last week and beat expectations. Yet the guidance for first-quarter revenue was lower than analysts had hoped for, and comments by management about too much inventory in the system lent fuel to the selling frenzy. Articles with headlines such as "Power-One Is Dead Money" quickly followed, and the shares are back down near where I bought them three months ago.
Actually, the entire solar sector took a hit because of the bad news. U.S. competitors SatCon (Nasdaq: SATC ) and Advanced Energy Industries (Nasdaq: AEIS ) were down significantly, as were solar panel makers such as First Solar (Nasdaq: FSLR ) and Suntech Power (NYSE: STP )
Nothing's really changed
The arguments I made in my original buy article remain true. The market is growing rapidly despite slowdowns in single countries (last year it was Spain, this year it's supposed to be Germany); the company is expanding beyond Europe, opening a brand new manufacturing plant in Phoenix and China to serve the U.S. and Asian markets; and the company continues to gain market share, sitting at No. 2 at 13% -- up from 11% just last summer -- behind Germany's SMA Solar Technology which has about 40% share.
Furthermore, while the rest of the industry was raising prices in 2010, Power-One wasn't. Thus, it should not be hurt as much by an expected decline in pricing. Power-One is projecting just 8% to10% declines, well below industry analyst IMS Research's call of 10% to 15%.
All the commentary I've read since Thursday's release leads me to believe that the market is looking no further than the next one or two quarters. For instance, Mark Bachman of Auriga Securities, which still holds a $13 price target, said, "This stock is dead money for one to two quarters, and clients need to be comfortable with the second half sales ramp. Investors will shy away from the stock until they feel better about future inverter sales."
The trouble with that kind of thinking is that if we wait for evidence that investors are "comfortable," a significant portion of any upward movement will likely be missed. As Warren Buffett says, "You pay a high price for a cheery consensus."
Still a Messed-Up Expectation
At the pre-earnings release price of $11.75, Power-One had little growth of free cash flow priced in -- just 3.4% per year for five years, 1.7% for the next five, and nothing after that (using my normal hurdle rate of 15% to discount). This is much lower than what I believe the company is capable of. At $9.26 as of last Friday's close, expectations are that FCF will decline for the next 10 years.
If instead the company actually manages to grow FCF by just 10% a year for five years, 5% for the five years after that, and then no more growth ever again, then shares are worth at least $16 today. I think that kind of growth's more than doable.
The company has shown that it can successfully play in the power inverter space, moving rapidly to the No. 2 spot. It grew revenue at a phenomenal rate in 2010 without trying to gouge its customers with higher prices, and will now reap the benefits of that restraint. And, it is expanding into other locations, moving away from the more mature European market. All that adds up to a reason to buy.
But of course, this takes a longer viewpoint than just the next quarter or two.
Tomorrow, the Messed-Up Expectations will double its initial investment in Power-One, upping it to a 4% position.