Description

TPI Composites (TPIC NASDAQ $28.86, “TPI”), a manufacturer of composite wind blades and bus bodies, is a stock I believe can at least double in price over the next two years.  My target price is $58 based on a 10x EV/EBITDA multiple of projected 2020 EBITDA.  TPI is a story of a quality management team driving a leading company within a growth market that has oligopolistic characteristics.  Long term contracts are in place with its customers, who act more like partners than clients. Operating margins are increasing from economies of scale and increasing efficiency of processes.  The business model is diversifying into new products funded from strong free cash flow (“FCF”). The risks include customer concentration, emerging country manufacturing facilities (China/Turkey/Mexico), large ownership by its Private Equity (“PE”) backer, supply chain commodity pricing, and exposure to the vagaries of governments’ views of wind power.  I believe these risks are mitigated by the cost of wind energy becoming increasingly competitive with traditional utility costs, environmental benefits, high barriers to entry for new competitors and TPI’s dominant market position. The wind energy market and TPI are well positioned for strong growth over the coming few years.

I believe that TPI is undiscovered by larger equity managers due to the limited float caused by the high level of PE ownership and the depressed level of current revenues and earnings due to the significant contract wins which require upfront investments in capital and employees.  These two issues are positive for small cap investors who can get comfortable with the business prospects for TPI. By 2019 TPI will begin to generate increasing revenues and cash flows which are being masked by the strong buildup in new and repurposed manufacturing lines. The stock is trading at an Enterprise Value (“EV”) to EBITDA of 10x current year, 6.7x projected 2019 and 5x projected 2020.  I see no reason this shouldn’t trade at 10x projected 2020 EV/EBITDA by late 2019 reflecting its business prospects and market leading position.

Overview

The company was founded in 1968 as Tillotson Pearson Inc., a high-performance composite sail and power boat manufacturer.  In 2004, TPI was acquired by Landmark Partners and TPI Management. The company had its IPO in July 2016. Composites provide a variety of advantages over metal-based structures, such as weight savings, corrosion protection, design flexibility and parts integration.  As such, with the advent of the wind energy market, TPI, with its composite manufacturing knowledge, was ideally positioned to capitalize on this growth opportunity, and began transitioning out of the boating market starting when the current CEO joined in 1999, fully exiting the boat market in 2004.  Please see timeline below.

Source: company reports

Today, Scottsdale, AZ based TPI Composites, Inc. is the only sizable independent global manufacturer of large scale industrial composite components, mainly wind blades and bus bodies.   Geographic location of the manufacturing plants is essential for cost efficiencies, as freight costs for shipping the up to 70-meter long blades are significant. The company operates nine wind blade manufacturing plants, and three tooling and R&D facilities across four countries. It is currently developing a new manufacturing hub in Yangzhou, China that is scheduled to open in the first half of 2019. It is designed to be state-of-the-art and will reliably and cost effectively serve the China and global onshore and offshore wind markets via land and by water from the Port of Yangzhou.  Further, in 2018, TPI is opening a new precision molding and assembly systems facility in Mexico. In the United States TPI manufacturers wind blades in Iowa, has precision molding and assembly systems used for the manufacture of wind blades in Rhode Island, and has just completed a greenfield plant for composite solutions for the transportation industry in Iowa that is currently producing bus bodies. It also has R&D facilities in Rhode Island, Massachusetts and Denmark. In Asia wind blades are made in three facilities in China. The Mexico segment manufactures wind blades from 3 facilities in Juarez. The Middle East and Africa segment manufactures wind blades with 2 plants in Izmir, Turkey.

Wind Market

Renewables have emerged as alternatives to fossil fuel-based supplies within the power sector. Solar, wind and grid storage are still at early stages of a rapid growth path.  Policy at the international, national, state and city levels and demand from businesses and consumers provide a strong impetus for the age of oil and gas to transition into the age of renewable energy.  An extension of the Wind Production Tax Credit (“PTC”) through 2019 for both new turbines and repowering of existing turbines along with IRS clarifications that expand PTC eligibility allowing developers 100% PTC benefit as late as 2021.  Wind energy and related segments are projected to grow at above 8% annually as highlighted below.

Global annual wind power capacity additions are now expected to average over 67 gigawatts between 2018 and 2027 or a 10-year CAGR of 8.3% according to MAKE Consulting (“MAKE”), which upgraded its forecast made in the 1Q’18 by 78% between 2020 and 2024. This forecast also estimates that the top 20 emerging markets will grow at a CAGR of 26.7% between 2018 and 2027. The U.S. market is expected to be robust over the next several years with expected annual installations averaging nearly 10 gigawatts through 2021 according to MAKE.  MAKE estimates 55 gigawatts of coal capacity will be retired by 2027 and the U.S. Energy Information Administration has indicated that nine nuclear plants with a combined 11 gigawatts of capacity have announced plans to retire by 2025 with an additional 9 gigawatts of capacity expected to be retired by 2050.

The New Energy Outlook report concludes a dramatic shift to 50% wind and solar by 2050, driven by cheap renewables generation and falling battery costs. Solar and wind costs are expected to drop 71% and 58% respectively by 2050 and this is expected to result in wind and solar representing 79% of all new generation capacity through 2050.  Denver has become the 73rd city in the United States to commit to a 100% renewable energy target. Utilities are using wind to grow their businesses and meet aggressive CO2 emission reduction goals.

Cost of Wind Energy

As you can see in the below charts, the cost of wind energy has decreased significantly from more than 60 cents per kilowatt-hour (kWh) in 1980 to about 7 cents/kWh in 2015, unsubsidized.  Further, in 2021 the cost should be lower than traditional fossil fuels according to Windpower E&D, and further backed up by the Lazard and other charts shown below.

Source: Windpower Engineering & Development

In addition to the wind market, TPIC is well on its way to diversifying its product base with a current agreement to produce bus bodies for Proterra, with the first chassis coming off the production line in July 2018.  While this isn’t factored into my model, it clearly provides some upside. Further developments are underway with electric vehicles (“EV’s”), commercial vehicles and passenger automotive as well as aerospace. While much of this is in the R&D phase, we see substantial opportunity for TPI to diversify over time.  In EV’s, lighter weight equates to longer range or fewer batteries which drives cost down. By 2040, 55% of all new car sales and 33% of global fleet are expected to be electric according to BloombergNEF.

Customers:

TPIC is well positioned in the U.S. Wind Power Generation Industry with current customers accounting for 99% of the U.S. market share in 2017.  TPIC believes it has 13% of the global market and provides wind blades to some of the industry’s leading OEMs such as Vestas, GE, Siemens/Gamesa, Nordex, Senvion and ENERCON.  

Substantially all revenues are derived from four wind blade customers as shown in the below chart.  

Source: Company Reports

Current trade wars with China and Mexico could cause the imposition of tariffs, which would necessitate cost increases from a TPI perspective.  However, TPI has a shared savings model with its customers and generally has contractual rights to pass through costs to customers.

A previous overhand for the stock was GE’s acquisition of LM in April 2017 which brought with it speculation that GE would bring the manufacture of wind blade lines in house.  However, in the second quarter of 2018, TPIC announced that GE would be extending contracts in place and adding additional lines with TPIC. Furthermore, the LM acquisition could provide additional longer-term opportunities for TPIC, given GE competitors are not likely to want to outsource their proprietary wind blade designs to a competitor.  

Management

CEO Steven Lockhard joined TPI in 1999.  Prior to TPI, he served as the Vice President of Satloc and was a founding officer of ADFlex solutions, a NASDAQ listed company.  He is currently the Chairman of the Board for the American Wind Energy Association (AWEA). The Company’s strong record of growth and solid backing of its PE partners, has enabled TPI to attract world class talent to its team over the past few years.  Starting with the hiring of the current CFO in 2013, a succession of quality management has joined the team. All totaled the company has over 9,000 employees worldwide.

Additions to management

• 2013

• Bill Siwek - Chief Financial Officer - was CFO for T.W. Lewis Company, EVP of Talisker Inc., President & CFO of Lyle Anderson Company and was a Partner at Arthur Andersen in both Audit and Business Consulting

• 2015

• Mark McFeely - Chief Operating Officer -  was SVP and COO of Remy International, VP – Operations of Meggitt Safety Systems, Inc. and held various leadership positions with Danaher Corporation and Honeywell International, Inc.

• Steve Fishbach - General Counsel - was SVP, Deputy General Counsel of Global Cash Access Holdings, Inc. (NYSE: GCA) and various senior roles in the legal department of Fidelity National Information Services, Inc./eFunds Corporation (NYSE: FIS)

• T.J. Castle - SVP – N.A. Wind and Global OpEx - held a number of positions with Honeywell including most recently VP of Integrated Supply Chain and prior to that was Global VP of the Honeywell Operating System for Aerospace

• 2016

• Ramesh Gopalakrishnan  - SVP – Technology & Industrialization-  was EVP of Global Manufacturing for Senvion Wind Energy. Prior to that he was COO of Suzlon Energy Composites, Inc. and has also spent time at Haliburton Corp. and GE

• Deane Ilukowicz - SVP – Global Human Resources - was VP of Organizational Effectiveness at TransUnion, Chief Human Resources Officer for Hypertherm, and held senior level roles at other financial services and manufacturing companies

• 2017

• Joe Kishkill - Chief Commercial Officer -  was President, International and Chief Commercial Officer of First Solar, Inc., President, Eastern Hemisphere and Latin America for Exterran Holdings

• Joe Kerkhove - SVP – Strategic Markets - was Commercial Vice-President with Arconic (ALCOA) and has over 20 years of sales and marketing experience to TPI, including leadership positions in Aerospace, Defense and Automotive markets Name Affiliation

Financials:

TPI has significantly grown revenues over the past few years and is poised for continued growth.  I am currently targeting 31% revenue growth in 2019 and 17% in 2020. TPI has stated it expects to reach $2 billion in revenues over the next few years.  I believe this is a realistic goal. This year has been an investment year for TPI with many lines being transitioned to new customers and larger blade designs.  While the cost of the new lines is shared by the customer, the lack of revenue from the down time has been a drag on TPI‘s current financials. The below chart highlights the increased costs associated with such growth initiatives.  With new lines averaging about $43mm per line, and historic lines running at $35mm, as the company expands to 61 lines installed by the end of 2020, we could easily see the company reach the $2 billion annual revenue milestone. Current agreements in place through 2023 indicate a backlog of $6.4 billion provide significant visibility. The following charts highlight key financial metrics showing the effects of current contracts and investment on future revenues, earnings and performance.

I believe Billings are a better indicator of growth than GAAP revenues, given they reflect work completed versus sales.  Total Billings refer to invoiced amounts; sales reflect delivered product. Often customers will not take immediate delivery of invoiced product, thus making Billings more relevant to current performance than sales. The following chart shows the strong historic and projected growth stemming from the $6.4b pipeline.

While the gross margin has declined given the above mentions line transition phase, I expect operating leverage to return and margins to approach historic highs as shown below.

The impact of the transitional stage, while significant, highlights the strrong cash flow charasterics of TPI, whereby even during a transitional stage, EBITDA remains positive.

TPIC maintains minimal financial leverage positioning the company to be able to continue to diversify into the transportation market utilizing the modeled cash flow shown above.

Competition

The wind blade market is highly concentrated with both outsourced and vertical integration strategies employed by participants. In April 2017, GE Wind, TPI’s largest customer, completed its acquisition of LM, TPI’s largest independent competitor.  The outcome was not negative for TPI as GE subsequently strengthened its ties with TPI through additional orders and improved contract terms to the Company. TPI also competes primarily with other independent wind blade manufacturers, such as Tecsis GmbH, Sinoma Science & Technology Co. Ltd., Shanghai Aeolon Wind Energy Technology Development (Group) Co., Ltd., Aeris Industria E Comercio De Equipamentos Para Geracao De Energia S.A. and ZhongFu Lianzhong Composites Group Co., Ltd., as well as regional wind blade suppliers.

Given the long-term contracts, significant startup costs, and expertise needed, there are material barriers to entry to compete in this marketplace.  Thus, we do not believe there will be any meaningful new competition emerging in the foreseeable future.

Risks:

In addition to the normal risks any company faces, including loss of key management and economic pressures, I believe the below risk are the important to understand when investing in TPIC. competitive pressures

• Customer Concentration – with 4 companies historically representing the bulk of TPIC revenues, the loss of any one of these customers would be meaningful. I believe TPI’s key customers are more akin to partners and would face significant switching costs if they moved to a competitor.

• Country Risk – Trade policy with China, Turkey and Mexico, as well as global instability in some of these regions poses a risk.  TPIC has Madeline’s Albright’s consulting company working alongside it to help navigate the challenges of operating in these countries.

• PE overhang – As with any PE overhang, TPIC will continue to see the PE firms exit their positions.  Historically this has been done thru block trades and given the strong performance of TPIC stock, I believe the PE sales will continue to be administered in a systematic fashion, selling into strength.

• Commodity pricing – Epoxy is a key component of the manufacturing process and fluctuations can impact short term performance; longer term prices flow thru to the customers.

• Government mandates and incentives – Historically renewable energy was subsidized with PTCs and mandates which are winding down.  I believe the Levelized cost of energy (LCOE) advantage of current wind designs make wind a viable energy source on a stand-alone basis.

Valuation and stock outlook:

In TPI’s IPO, 6.3 million shares were floated, with insider shares retaining an additional 26 million plus shares.  Currently we believe the insiders, most notably the PE investors, own just over 50% of the stock. The insider position came off lock up in January of 2017, creating a significant overhang on the stock.   We expect these shares to be sold as TPI demonstrates the power of its backlog through growth in revenues and cash flow. Over time as this overhang decreases in size, and the related float of the stock increases, we believe the stock’s multiple will expand.  The company currently has an approximate $950m enterprise value (“EV”), with estimated 2020 EBITDA of $184mm from just the wind business, indicating a 5x forward 2020 EV/EBITDA multiple on the stock. I believe this multiple could double over time to 10x as growth continues and TPIC solidifies its position as the global leader in composite structures and diversifies beyond the wind market. My forward EV multiple does not include additional cash generated that will be on the balance sheet.  Our target price of $58, conservatively factors only the net income generated over the next 2 years of $153mm into our EV calculation.

Conclusion:  

TPIC is well positioned with a quality management team, a leadership position in a growth industry and a strong balance sheet to continue to prosper as wind energy proliferates throughout the globe.   Coming out of the current transitional period, whereby costs are out-sized and revenues are minimalized, I believe TPI will return to historic margins and cash flows, allowing the company to astutely diversify into the transportation market providing upside to my estimates.  Further as the market cap and float both increase, I believe an investment in TPI will be more attractive stock for larger funds to invest in meaningfully. Thus, I believe the stock will at least double to my target price of $58 over the next 2 years.

Catalyst

1. Revenue and earnings growth from already signed contract wins.

2. Additional growth due to increased global demand for wind power due to its decreasing cost and renewable position.

3. Upside to projections from bus manufacturing operation.