After handily outperforming the market last year, solar stocks have been one of the worst-performing industries so far in 2021. Few have done worse than Array Technologies (ARRY 6.66%), which has seen its shares collapse nearly 70% year to date as of this writing.
Array serves a niche role in the industry, making trackers that attach to solar panels to help improve performance. Here's why shares of Array Technologies could be a great under-the-radar buy at the newly discounted price.
Challenging but temporary headwinds
After Array reported first-quarter earnings last week, its stock shed over 40% of its value on May 12. The Suez Canal accident and the February Texas winter freeze raised Array's storage and shipping costs. The company's quarterly revenue and net income took a turn for the worse and it retracted its full-year guidance. There is a lot of work to be done surrounding supply agreements and customer contracts to adjust to these higher costs. Management was honest about its mistakes and acknowledged just how susceptible the business is to rising steel and shipping costs.
Steel and shipping costs are rising because global business is recovering at a faster rate than the supply chain can handle. The COVID-19 pandemic induced a rapid decrease in industrial production and a surplus in the supply of many commodities. With such a rapid ramp-up, producers will need time to fill orders and meet customer demand.
Array is facing a potentially lose-lose situation. It can accept higher costs, cripple its margins, maintain its customer relationships, and potentially grow its base. Or it can raise prices and risk losing customers and market share.
Management indicated that cost of goods sold (COGS) could very well remain high throughout the year due to rising steel prices, which would wreak havoc on Array's bottom line. The company also indicated that the two-year extension to the solar investment tax credit (ITC) gives customers plenty of time to start new projects. With the extension, higher commodity prices, and higher interest rates, developers will be less inclined to start projects -- which is bad for Array's business.
As worrisome as these challenges are (and they are deeply concerning), they shouldn't persist past the short to medium term. Like other cycles, the relationship between steel prices and supply, as well as shipping rates, should normalize, which will reduce Array's costs.
Now, it's just an issue of timing. The longer it takes for commodities to normalize, the more Array will be pressured to raise prices. However, management believes that Array's competitors could experience an even greater headache, which could lead to a shakeout, consolidation, and an even greater advantage for Array over time. It's too early to tell whether or not Array will be able to capitalize as it hopes. Either way, it's worth understanding that commodity price challenges are not a firm-specific problem, but rather, a shared challenge affecting the industry.
Handling the problem
Given Array's decision to suspend guidance, and its indication there could be more pain ahead, it's not too surprising to see the renewable energy stock dramatically sell-off. Although caught off guard, Array has been leveraging its industry-leading reputation to secure supply agreements. The most notable is with Nucor, America's largest steel company. Array refrained from disclosing the specifics of the deal but said that the agreement will give it steel components at a fixed price below spot. In other words, Array has basically put a hedge on the price of steel so that it can reevaluate its business in the short term.
In addition to steel contracts, Array is entering a long-term contract with Tier 1 freight to help provide clarity on logistics and turnaround times. In the past, Array cited on-time performance and easy installation as two of its key competitive advantages. An ability to properly forecast deliveries during a challenging time could help separate Array from its competitors and help it retain its favorable reputation.
In late April, Array announced a 4-gigawatt (GW) contract with Primoris Services Corporation, one of the largest solar engineering, procurement, and construction (EPC) contractors in the U.S. With shipments set to commence in June, the deal will provide Array steady business during a difficult time.
This is the largest contract Array has announced as a public company -- much larger than the 1 GW deal with RP Construction Services or the 1.4 GW agreement with Lightsource BP (both announced in November 2020). In its 32-year history, Array Technologies has installed over 22 GW of commercial and utility-scale solar projects globally. A 4 GW contract is a meaningful addition to its existing installed base.
The bottom line
Management's tone during Array's most recent earnings call was candid yet confident. The company didn't shy away from the challenge, knowing full well that the current market environment is likely to stunt its 2021 growth and profitability.
As painful as the drawdown has been, the sell-off could actually be a good thing for investors looking to buy now. Expectations for the second quarter and the remainder of the year are now low, meaning any good news could help alleviate downward pressure. By the same token, a prolonged period of higher steel prices and weaker profit margins could drive the stock down even further. More importantly, Array's long-term strengths remain intact. The solar industry presents one of the most attractive opportunities in energy, and Array plays an important role in that growth.