It was a very good year for investors in solar panels manufacturers SunPower (NASDAQ:SPWR) and First Solar (NASDAQ:FSLR), as both enjoyed a spectacular bull run. Will these companies repeat this staggering performance in 2014? Is it still worth entering this market? Let's start by examining the recent developments in the solar energy market.
Always the sun
The solar industry is a growth industry that has sharply expanded in the past year. The Energy Information Administration projects that U.S solar demand has increased by over 32% during 2013. Moreover, according to the Solar Energy Industries Association, during the first nine months of 2013, there was an 18% rise in installation of photovoltaic (PV) capacity in the U.S. Despite these high numbers, leading solar manufacturers haven't augmented their revenues by similar rates. SunPower's revenue rose by 7.5% during the first nine months of 2013.
On a yearly scale, SunPower's management estimates its annual growth in sales will only be around 2.4%. First Solar's net sales grew by nearly 11% in the first three quarters of 2013. Its management recently revised down its 2013 annual guidance and estimates its revenue will rise by only 4% and not 10% as it initially projected. So even though this industry is growing fast, both companies' revenues didn't rise at such a pace. Based on the recent update from the Solar Energy Industries Association, one reason is likely to be the ongoing drop in solar panels prices, which have tumbled 60% since early 2011.
For 2014, the EIA estimates that U.S solar energy consumption will increase from 0.309 quadrillion Btu in 2013 to 0.418 quadrillion Btu, which is roughly a 35% growth in consumption. In comparison, total renewable energy consumption is estimated to rise by less than 3% during 2014. Thus, solar energy is expected to be the fastest growing renewable energy source in 2014.
The U.S. government's decision to reduce CO2 emissions by enforcing fines and additional environmental costs on utility companies is likely to also shift companies such as FirstEnergy (NYSE:FE) toward purchasing or generating renewable energy. Currently, renewable energy accounts for only 11% of FirstEnergy's fuel mix. Similar environmental restrictions are also enforced on a state level; for example, last year FirstEnergy sought out solar generated power in order to meet its renewable energy requirements in Ohio. Therefore, the support of U.S. policymakers on both federal and state levels is likely to fuel the demand for solar energy. Despite the little growth in sales of leading solar manufacturers, their profitability rose.
Profitability is improving
During the past year, SunPower and First Solar were able to widen their gross profitability: SunPower's gross profitability rose to 26.5% in the first three quarters of 2013. Back in 2012, its profit margin was 24.4%. First Solar also improved its profitability from 12% in 2012 to 19% in 2013. These companies have also increased their net earnings partly due to a reduction in SG&A.
Furthermore, for SunPower, the sharp rise in revenue in the Americas and drop in sales in EMAE also widen its profit margin. Despite these developments, the fall in the price of solar panels, as stated earlier, could also adversely affect profitability down the line. The improved profitability has increased the valuation of these companies. Let's examine how they're priced compared to the industry average.
In order to analyze their valuation I have compared their enterprise value and EV-to-EBITDA ratios. The table below shows the summery of data of SunPower and First Solar and the average power industry.
The EV-to- EBITDA ratio considers their different financial structure, including their level of debt and cash on hand. SunPower's debt burden is much higher than First Solar's: SunPower's debt-to-equity ratio is 0.94, while First Solar's debt-to-equity ratio is only 0.05. This means SunPower's financial risk is higher than First Solar's and it must endure higher interest costs.
As you can see, both companies' EV-to-EBITDA ratios are very far off form each other and from the industry average. First Solar's ratio is only 4.72, while SunPower's ratio is over 27. In comparison, the power industry average is 9.8. The wide gap between valuations is because SunPower's stock jumped by nearly 300% in 2013, while First Solar's stock rose by "only" 80%. These factors suggest, at face value, that First Solar's current valuation is low compared to SunPower's and the industry average, which makes First Solar a better priced investment.
The bottom line
The expected rise in the demand for solar power is likely to fuel an increase in revenue for solar manufacturers. If you were to consider entering the solar power industry, it seems that First Solar might be a better fit in terms of valuation, growth in sales, profitability, and financial stability. But keep in mind that the ongoing drop in the price of solar panels is likely to cut down profitability, which could reduce their valuation down the line.