There was some great news for the solar sector on Thursday and Friday: SunPower (SPWR)
It's important to focus on the improvements that SunPower and Suntech were able to demonstrate, which were significant and relate to both the companies' balance sheets and the improved demand in the fourth quarter. Ultimately, though, it's going to be as important to assess whether the companies provided any incrementally positive view about 2012.
How SunPower Beat
SunPower reported earnings of $0.16 in the fourth quarter, better than the $0.05 loss Wall Street consensus called for. But keep in mind that the consensus was predicated on SunPower booking revenue from its California Solar Valley Ranch project at $100 million in the quarter. The company booked $186 million in revenue from the project -- which is a high-priced power purchase agreement contract, meaning lucrative -- and that swung earnings by $0.19, according to Stifel (SF) analysts.
The large-scale project business is "lumpy," in that it is hard to model when the project revenue will hit the books quarter to quarter. So it's important to look within the "SunPower beats" headline to the trickiness of modeling project revenue and how that creates a big beat.
SunPower guided to a loss in the first quarter of 2012 of between $0.05 and $0.20 a share. The company's revenue guidance for 2012 implies that it at least meets the Wall Street consensus, with a range of $2.6 billion to $3 billion. SunPower said it is "committed" to earning money in 2012, but with the only quarter for which it provided specific guidance, it expects to lose money.
The situation was improved in the fourth quarter, but SunPower's profitability isn't necessarily improving in 2012. Steve Simko, analyst at Morningstar (MORN), also cautioned that while SunPower said it is committed to earning money in 2012 and it guided to a revenue high-end of $3 billion which is above the consensus, the company revised guidance several times in 2011.
Better Gross Margins
SunPower reported gross margin of 12.4% in the fourth quarter, and the big part of that was the project business, where margins were above 17%. Residential and commercial gross margin was at 7.5%, which continues a margin trend that has gone straight down from 23% in the first quarter 2011. For the first quarter 2012, SunPower guided blended gross margin lower to a range of 9% to 11%.
"While non-GAAP revenue recognition from the CVSR led to a better than expected quarter and 2012/13 North American UPP pipeline looks healthy, the overall solar market conditions continue to be challenging and pricing aggressive, as demonstrated by the pressure on R&C margins that continued to drift lower for the sixth consecutive quarter," Stifel noted.
Simko said he estimates that the CVSR project generates gross margins of 21% for SunPower. "That's as good as it gets for them," he said.
Cash Gift for Shareholders
SunPower released $140 million in restricted cash, and according to Morningstar's Simko, that's a significant catalyst for shares that have been trading below $8, as the surprise cash addition can have a significant impact on the share valuation.
Aaron Chew, Maxim Group analyst, also noted that while SunPower ended the fourth quarter with more than $650 million in available cash, the short-term outlook remains challenging. The company forecasts it will end 2012 at $300 million in cash, which a Goldman Sachs analyst on the earnings conference call estimated to represent cash burn of an additional $150 million over the next 12 months. "They are still losing money and will be for the foreseeable future, and the most telling comment from the earnings was the expected cash decline of $150 million," Chew said.
Cost Reduction on Target
SunPower's cost-reduction plan came in within its previous guidance, with costs down to $1.42/watt in the fourth quarter, but even with the huge strides it has made in the past two years, going down from a cost of $2/watt to $1.46, the company still wasn't profitable for the full year 2011.
This remains the primary concern of analysts. As Simko said, "We've seen these big cost reductions but we still have a bottom line where even excluding good will it's negative for 2011." Simko said with pricing likely to continue down in 2012 it is still difficult to be a bull on the SunPower profit story.
Stifel noted, "SunPower continues to execute on its cost reduction initiatives, but we have not seen a meaningful acceleration in efforts despite increasing pricing pressures, and believe a near-term 15% cut will not be sufficient."
North America was a huge quarter for SunPower in the fourth quarter of 2011, and that is a good read on the demand in the U.S. ahead of the expiration of the solar cash grant, which was expected to spur solar installations. That benefits all companies, and the upward shipment guidance revision from Suntech on Friday also suggests that the U.S. likely helped all solar companies in the final quarter of the year. However, SunPower's outlook for the full year 2012 is still majority-European business. That presents a note of caution because the feed-in tariff situations in Germany and Italy remain potential negative catalysts for solar demand.
Solar companies have gone out of their way to show that they are becoming more geographically diverse and insulated from the European pressures; however, SunPower expects 450 megawatts to 575 megawatts of demand to be European in 2012. North America is second at 375 megawatts to 500 megawatts. In addition, the company is guiding to the residential and commercial market -- where its margins have been under the most pressure -- to be the majority of sales.
"Management now expects Europe to account for over 50% of 2012 shipments post 1Q12. We see increased regulatory risks in the region, and believe that with the increasing shift in Europe toward rooftop systems and away from large ground mounted plants, the dealer channel will become more important and will face a severe test as prices are likely poised to fall further," Stifel analysts wrote.
One of the more bullish views on SunPower came from analyst Hari Chandra of Auriga Securities, writing, "We note that should SunPower radically address its cost structure issues in 2012, it will be fashioning a future that is full of promise. While hopeful, we are also mindful that structural fixes take time." SunPower was at his $9 price target after a 20% spike on Friday morning.
The good news from Suntech was about the balance sheet
Suntech reported shipment and revenue guidance for the fourth quarter ahead of the Wall Street consensus, but the most important news from the company was evidence of capital discipline. Suntech has one of the worst balance sheets in solar, and the company made good on a promise of reducing net debt during a difficult time for the solar sector. The company reduced net debt by $200 million in the fourth quarter and reduced working capital - accounts receivable and inventory -- by $450 million.
Morningstar's Simko said that is significant for a company at which the balance sheet remains the No. 1 concern.
"I don't think the stock is reacting to the revenue number or shipments being down 10% rather than 20% quarter over quarter, but to the reduced working capital. That is a huge thing as the company has been stressing balance sheet improvement. They've talked a big game in the past about doing better with the balance sheet stress and now they are getting their act together," Simko said.
Shipment Decline Less Than Expected
Suntech said fourth-quarter shipments will only decline by 10% rather than the 20% sequential decline it had expected, and as a result, revenue will beat the Wall Street consensus, coming in at $610 million to $630 million. The Wall Street consensus was at $558 million.
However, Suntech is likely to still lose money in the fourth quarter, according to analyst Aaron Chew of Maxim Group. Suntech said gross margin will come in around 10%, and at that level, the company isn't making money, Chew said.
"The news is not that solar is healthy again, but that there will be demand upside, yet margins won't go anywhere," Chew explained. "Suntech has had a miserable time generating cash flow and now they are facing a downturn. The improvements indicate they will be fine cash-wise and that alleviates near-term liquidity issues, but what you need is sustainable operating cash flow," the analyst added.
Bottom Line in Solar
The three pillars of good news to end the week and spark the rally were significant.
First Solar receiving a permit that will free up funding for its key Antelope project is a huge part of its earnings story in 2012. Shares didn't return to their 2012 high on Friday, but the spike of 10% was merited given that shares had sold off after the worry about the project funding was revealed.
First Solar shares were still not back at the high they had reached for the year on Febuary 9.
Suntech, even after rallying by 11%, was not back at the 2012 high it had reached on Febuary 9.
SunPower was the only stock in the sector among a huge rally that was pushing through last week's high.
All in all, this was one more volatile trade for a volatile sector and the headwinds are still significant. Fourth-quarter shipments may continue to exceed expectations as companies report, but with the demand pull-in from Germany and the U.S., that's not entirely unexpected. Meanwhile, the risk of Germany dropping a bomb on the sector with a severe restriction of solar subsidies remains front and center for these stocks and a reason why they may not eclipse last week's highs for the year, or in the least, will continue to trade with the sector's typical high volatility.
"When you cut through the noise, the bottom line isn't improving amid the stock rallies," Simko said.
It's a view that solar investors should, in the least, consider as they try to weigh improved fourth-quarter results against near-term 2012 headwinds for the sector.