SunEdison Surprised Wall Street: It´s Time to Be Long on Energy Finance

In this article, let's take a look at SunEdison, Inc. (SUNE, Financial), a $5.76 billion market cap solar company, in which some months ago the hedge fund manager David Einhorn (Trades, Portfolio) disclosed a "large" long position, according to Bloomberg News.

1. Company history and business

SunEdison (formerly MEMC Electronic Materials, Inc.) is a semiconductor and solar technology focused company. The company’s semiconductor business has designed and developed silicon wafer technologies for over 50 years.

It designs, manufactures and provides wafers and intermediate products for various industries including the semiconductor, solar and other related ones. For example, it supplies wafers of varying sizes, including 100mm, 125mm, 150mm, 200mm and 300mm to the semiconductor industry. Products are used in computers, cell phones, other mobile devices as well as in the automobile industry, among others.

The company is a leading solar energy company with operations in the U.S. and other international key markets like Europe, Japan, Malaysia, South Korea and Taiwan.

SUNE has now two reportable segments: Semiconductor Materials and Solar Energy. In the first segment, it competes with Shin-Etsu Handotai, SUMCO (SUMCF, Financial), and Siltronic. In the latter, competition comes from SunPower Corporation (SPWR, Financial), First Solar Inc. (FSLR), Recurrent Energy Inc., T Solar Global, S.A. and Fotowatio Renewable Ventures.

2. Financial strength

SunEdison has significantly increased earnings per share (EPS) in the second quarter compared to the same quarter a year ago (from -$0.45 to $0.12), beating the Zacks Consensus Estimate. With this result, the firm moves over poor performance. It has reported a trend of declining earnings per share over the past year. However, the consensus estimate suggests that this trend should reverse in the current year.

Comparing actual earnings to analyst estimates is also helpful. An earnings surprise can move a company’s stock price, but actually it had an erratic behavior.

Source: Yahoo Finance

In the second quarter, it reported GAAP revenues of $646.2 million, an increase of 61% year over year; and non-GAAP revenues (after adjustments) increased by 13.4% year over year.

The gross profit margin is relatively low; it was down from 5.9% reported in the year-ago quarter to 4.6%. A negative operating result of $108.9 million in the quarter, below the figure reported in the same quarter one year ago. This operating loss could be attributable to higher operating expenses and costs related to unsold projects.

Moreover, cash and cash equivalents were up to $954.7 million, almost doubling the previous quarter. Looking at the balance sheet, the solar company has a highly leveraged one. The long-term debt (without the current portion) stood at $4.91 billion.

Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has decreased from the same quarter one year prior. This is a clear sign of weaknesses within the company.

Let´s compare the current ratio with the peer group in the next table:

SunEdison has a tremendous negative ratio. We think that a ROE greater than 10% is quite enough to provide dividends to owners. For investors looking for a higher ROE, Cabot could be the option.

3. Management

SunEdison has one of the top management teams in the industry, and I think this will continue in the medium term. Management continuously focuses on improving the technology, as well as trying to increase market share. Efficacy can be seen through the success obtained in the agreements. Although the company has long-term supply agreements, its agreements are for one year.

The top management list is:

• Dr. Shaker Sadasivam
  Shaker Sadasivam, Ph.D., President & CEO
• Jeffrey L. Hall
  Executive Vice President Finance & Administration and Chief Financial Officer
• William J. Dunnigan
  Vice President and General Manager, Small Diameter Business Operations
• Bryan D. Hoadley
  Vice President, Sales & Marketing
• Srikanth Kommu, Ph.D
  Senior Vice President & Chief Technology Officer
• Donna Martin
  Senior Vice President & Chief Human Resources Officer
• Horacio Mendez
  Senior Vice President & General Manager, SOI & Advanced Solutions
• Sally Townsley
  Senior Vice President & General Counsel
• Doug Wilson
  Senior Vice President & General Manager, Global Manufacturing

4. Catalysts

a) David Einhorn (Trades, Portfolio)´s Reasons

Based on a statement from his letter to investors, “the declining cost of solar energy combined with the rising cost of conventionally produced electricity should position SUNE as a winner,” he sees how solar prices are falling and so betting on this stock. The average cost of a solar panel has fallen by 60% since 2011. Forward looking, solar companies will likely see larger markets and growing margins as the average residential retail electricity prices increased by the rate of inflation over the past couple of years and it is likely to continue that trend.

Further, the guru likes how "the company has built a large pipeline of attractive projects secured by credit-worthy buyers of electricity," the Greenlight letter said. In previous estimations, Einhorn calculated that if the company spun off those attractive projects in a Yieldco, the total value of the Yieldco would be worth around $34 a share, which means 70% higher than the stock price at that moment (which is a bit more than the actual level).

b) The spinoff

Because the semiconductor unit has been underperforming, it was set to be split from SunEdison. That was the reason why it plans to spin off its semiconductor businesses into a separate entity via an IPO. The Yieldco IPO was made with the idea that SunEdison could retain more high value solar projects on its balance sheet and provide a cheap source of capital. TerraForm (TERP, Financial) was the name of the spin-off and the reason to exist is to operate solar projects that SunEdison builds. The business model is quite simple in the way that it works. SunEdison offers the project to TerraForm, and the latter raises the capital and operates it. Then, it pays dividends to SunEdison. We must say that it completed its "yield co" unit TerraForm Power Inc.’s Initial Public Offering.

According to the deal, SunEdison will offer TerraForm solar projects and by the end of next year, those projects will generate $75M of cash available for distribution (dividends), in the first years after the project starts generating outcome. By the end of 2016, there will be projects generating an additional $100M of dividends. So a total of $175M is expected at the end of 2016.

With these numbers, I believe SunEdison's moves will start paying off, confirming Einhorn´s thesis to be positive and will boost earnings potential in the mid-to-long term.

c) Other key driver: FiT subsidizes

Markets all over the world, no matter if they are in Europe, Asia or Canada, are highly dependent on government actions for the majority of domestic installations. European governments are reducing the feed-in-tariffs (FiT). Germany, Italy and U.K were transiting this way for some years; like the state of Ontario in Canada. If subsidies continue, which are likely to remain, it will increase the pressure on the company's solar-wafer and solar installation business.

5. Valuation and price performance

SunEdison's stock has its "sell" rating (Zacks) but continues to be an interesting investment from a valuation standpoint, trading at a 2.3 P/S. Some of its major competitors include Entegris Inc. (ENTG, Financial), Cabot Microelectronics Corp. (CCMP, Financial), ATMI Inc. (ATMI, Financial) and Ameresco Inc. (AMRC, Financial). The following table compares the current valuations:

Shares jumped almost 12% the day Einhorn’s position was made public. The share price rose from $18.79 to close at just above $20. Take a look at the chart below to see this effect on April 22, the day Einhorn’s position was disclosed.

But they haven’t moved much since then. The chart below shows the stock’s performance in the last months.

As we can appreciate, there was a series of erratic movements up and down and then converges to a similar level to the one showed before. But it is worth noting that the stock has climbed more than 80% this year, the highest growth among its peers. One month ago, Canaccord gave the company a $30 price target, indicating an upside of around 50% from current levels.

6. Risks

First of all, we have to mention that wafers are commodities with limited chances for differentiation or pricing power. Therefore, the only way to be profitable is to increase volumes and keep costs down.

Furthermore, solar industries in Europe, Asia and Canada are highly dependent subsidy or tariffs for the vast majority of domestic installations.

Additionally, the solar wafer business is facing a strong risk due to the excess of polysilicon supply which adversely affects sales. If we imagine a scenario for the future where supply will continue to exceed demand, we can forecast a steady decline in pricing for polysilicon wafers. In order to mitigate this risk, the firm has to continue reducing prices to maintain market share. Lastly, competition from SunPower Corp. and First Solar Inc. also remain big risks.

7. Outlook

We believe that the company could reach a dominant and leader position if it continues to invest and improve on the technology used. Of course, this will lead to higher profits and a major portion of market share.

Polysilicon is one of the most abundant elements on earth. Due to its material properties, it is used as feedstock material in most solar energy applications. For the upcoming years, if we can imagine (and project) that the new production of polysilicon exceeds the demand, we will have a scenario of declining prices for polysilicon wafers. The company is reducing solar wafer prices in order to maintain market share, but margins are affected.

Further, the fierce competition from Chinese companies due to lower regulations and cheaper labor costs, generate an additional pressure to SunEdison.

8. Final comments

SunEdison has most of the major semiconductor equipment manufacturers as its customers. Further, we expect a growing solar activity – with the solar public vehicle launch it is possible to come soon – as well as the IPO of SUNE's semiconductor business in the coming months.

At the end of the second quarter, the hedge fund Greenlight has a large position on SunEdison as well as in other companies such as Apple (AAPL), gold, Marvell Technology (MRVL), Micron Technology (MU), Resona Holdings (TYO:8308)

Many investors are wondering if it is the appropriate time to buy it now. Einhorn indicated that Greenlight Capital’s average price-per-share is $15.55 and that he believes the value of the company is around $35 per share. Compared to the actual price of $20, the stock has potential upside of 75%. This make me feel bullish on this stock in a competitive environment which becomes more challenging and I think it could double in a twelve-month period.

I would recommend investors to consider adding the stock for their long-term portfolios. Hedge fund gurus have also been active in the company. Steven Cohen (Trades, Portfolio)'s Point72 owns approximately 12.7 million shares while Leon Cooperman (Trades, Portfolio) owns around 8.1 million shares.

Disclosure: Omar Venerio holds no position in any stocks mentioned