Description

Canadian Solar (CSIQ) - LONG THESIS

While the world around us seems to be imploding, I have become pretty bullish on the Solar industry – and believe it has reached a tipping point in terms of public perception, pricing/grid parity – as well as tangible environmental and consumer benefits.  Countries large and small are increasing their allocations to Solar projects.

Additionally, a structural shift is occurring within the industry. Similar to MLPs before them, a number of solar companies are creating YieldCo’s and are moving from a ‘build-to-sell’ model to ‘build-and-keep’ model (see the excellent SUNE write-ups on VIC). Solar companies are building and managing projects characterized by 10-20 year lives, solid visibility and contracted prices, and placing these projects in their YieldCos.

The motivation for Solar companies to adopt such a structure is simple. For companies such as SunEdison, SunPower, and Abengoa, holding Solar projects is often far more profitable in the long run than selling them. SunEdison has been quite clear about the long-term financial benefits. During Q1 2014, SUNE retained 74 MW of the PV projects that it completed, which captured an estimated $100mm in additional value.

Case Study: SUNE/TERP

SunEdison recently spun off its YieldCo TerraForm Power, which has been trading at ~2-3%. While many of these entities aren’t planning to grow their yield, TERP is expecting to grow its yields 15-20% per year. While specifics are yet to be hammered out, CSIQ announced it will be creating a YieldCo by year-end 2015/early 2016 and it is expected to grow its YieldCo rates at similar growth rates.

Thesis

Canadian Solar (CSIQ) is benefiting from several industry tailwinds, while possessing a robust module business and a very healthy balance sheet. CSIQ plans to spin off a YieldCo and has >2GW of high-probability projects over the next two years, as well as >6GW in early-stage pipeline projects (over 3-5 years) that can be dropped into its YieldCo.

Depending on what the market is willing to pay for a steady and growing yield, the upside can be significant. If the projects that drop into YieldCo are at a 6% yield, CSIQ figures to be worth ~$40/share. At 5%, CSIQ is valued at $50/share. At 4%, it's $60/share…and so on.

Not only is public sentiment working in your favor, but several countries outside of China and Japan are shifting their electricity needs to Solar. Coupled with a structure build for growing yield in an industry that’s been washed a couple of times over the past few year, and has consolidated its production. In other words, Solar is no longer levered to technology, but now levered to increasing economies of scale. Truth be told, I own SunEdison and SunPower as well, but believe CSIQ offers the most upside.

Description

Founded in 2001 in Canada, Canadian Solar (CSIQ) designs, develops, manufactures, and sells solar wafers, cells, and solar power products worldwide with successful business subsidiaries in 18 countries on 6 continents. In addition to being a leading manufacturer of solar PV modules and provider of solar energy solutions, CSIQ has a geographically diversified pipeline of utility-scale power projects. Together with its recent acquisition of Recurrent Energy, Canadian Solar’s total project pipeline now stands at 8.5 GW, including an increase in the late-stage project pipeline to 2.4 GW.

What’s Happened?

• In early March, CSIQ announced it was actively exploring a YieldCo IPO listing by year-end 2015 or early 2016 – sending the stock up ~15% (along with strong 2015 guidance around volumes). Few details were issued except its YieldCo is expected to have global assets and assets from third-parties.

• In mid-May, Yingli Green Energy (YGE) dropped by over 40% followed by Hanergy’s 50% drop soon after – causing the entire sector to fall.  Both of these issues were company-specific, but highlights the volatile (and perhaps speculative) nature of the Solar business.

• Today, CSIQ is down ~30% from its May highs, and I believe offers an excellent entry point for a compelling risk/reward with defined catalysts.

At CSIQ’s May Analyst Day, it provided further clues on its YieldCo structure:

• CSIQ plans to include OECD projects into its YieldCo, in addition to its 91 MW in US operational projects (none of its 1 GW late-stage Recurrent project pipeline will be completed until 2016). While relatively light vs. TERP and not offering the inherent US advantage of accelerated/bonus depreciation, CSIQ will likely get other developers to place their US assets into its YieldCo.

• Refinancing for projects in operation is another way TERP drove value, however CSIQ acknowledges the optimum refinancing window may have passed them by.

Anticipated YieldCo Structure

Initially, I believe CSIQ’s YieldCo will consist of:

• UK: 90 MW

• Japan: 45 MW

• US: ~250 MW

Unlike TERP which has a much larger US mix, CSIQ’s YieldCo will have to deal with greater tax complexities (related to accelerated/bonus depreciation), but will be lessened after the first year as the Recurrent pipeline comes online in 2016. Management will further minimize tax leakage by incorporating its non-US assets in the UK, similar to Abengoa YieldCo. CSIQ will also need to hedge its $US dividend payments produced by non-US FCF.

Assumptions:

• Module Business: I anticipate the module business will generate ~$2B in 2015 and ~$2.5B in 2016, with gross profits covering CSIQ’s firm-wide operating expenses.

• Interest Expenses: Annualized interest of ~9% (mostly China borrowing) should decrease as it shifts its borrowing to lower rate markets (Japan, UK, US) where projects are located.

YieldCo Replacement Value (2015)

Comparables

Risks

• CSIQ delays the launch of its YieldCo

• OECD YieldCo will have more complex tax/FX issues vs. previous Solar YieldCo with initial FCF driven by UK/Japan assets

• Subsidy programs in major markets (US, China, Japan) change for the worse

• Japanese Yen weakening

• Project financing/refinancing environment worsens

Conclusion

Over the short-term, the solar stocks are very correlated with oil – when oil prices fall, solar stocks get hit as they did in 2014. The truth is only 4% of the entire world produces electricity utilizing oil, so it makes little difference. Politically, every government in the world wants to be more environmentally-friendly and less reliant on the Middle East. The bottom line is you have a confluence of factors that make the Solar industry incredibly interesting, while the stocks themselves are under-owned, misunderstood and generally ignored. Since the entire industry has very little market cap in total, if I am correct on the secular solar trends – not a whole lot has to go right for CSIQ to work, especially in this yield-starved world.

Catalysts

• YieldCo IPO listing as planned

• China: 2015 potentially marks the first year Tier 1 module makers enjoy higher ASPs and profitability in their domestic market

Catalyst

• YieldCo IPO listing as planned
• Continued asset M&A to grow/extend yields
• China: 2015 potentially marks the first year Tier 1 module makers enjoy higher ASPs and profitability in their domestic market
• Maturity/Sentiment of Solar Industry