Canadian solar: Recovery won’t be quick, but could be significant (CSIQ)

Dear readers,

Canadian solar energy (NASDAQ:CSIQ) is a global vertically integrated solar energy company, one of the largest manufacturers of solar panels in the world and a major player in energy storage.

It is a company that I have studied extensively and covered it many times here on Seeking Alpha. And I can tell you that the only thing you need to know before investing in this is that CSIQ is very cyclical.

While the cyclicality should be evident from the price performance alone, there are fundamental reasons why the stock has experienced wild rises and falls and ultimately failed to grow despite significant growth in the two sectors in which it operates.

I have explained these reasons in detail in one of my previous articles. In short, solar panels are all more or less the same, meaning there is fierce competition in the space and the product has become quite a commodity. This is good for the consumer, as the price of solar panels has fallen over time (see chart below), but not so much for the manufacturers who spend millions on R&D and especially new production capacity in an attempt to capture demand when it is high, only to see inventory pile up when demand inevitably falls.

Because of this inherent cyclicality, I warned against buying the stock at $30+ a share last year, and only slowly started accumulating shares when the price started to fall. The last time I wrote about the stock, after Q1 earnings, the stock was very cheaptraded at a fraction of the value of its shares in the listed Chinese subsidiary CSI Solar Co. I concluded that the stock was a buybut I also brought some significant risks to consider. Simply put, I saw CSIQ as a high risk, high reward game.

To be fair, the performance since May has been poor with a negative RoR of 33%, compared to a mild RoR of the S&P 500 (SPX) index over the same period. This underperformance was likely caused by (1) worse than expected results for the second quarter of 2024, (2) reduced guidance, and (3) a macro environment that remains challenging for the sector.

Anyway, I’ve been slowly averaging out the stocks, which now make up just under 0.75% of my portfolio.

Results and guidelines Q2 2024

Canadian Solar reported its most recent results in late August. The company posted a slight revenue overrun, but a significant profit losses with actual earnings per share of just $0.02 per share, significantly below expectations of $0.10 per share.

That’s very low considering the company was generating more than $2 per share in earnings just 12 months ago, thanks entirely to low demand for solar panels, which caused revenue to drop 14% year-over-year.

Demand has been significantly lower than expected over the past year, mainly due to a difficult macroeconomic environment, which has also led to a continued downward trend.

In January, management expected 42-47 GW of solar panels to be delivered in 2024 (50% more than the previous year). At the end of Q1, that expectation was lowered to 35-40 GW (25% more than the previous year) and now the forecast is only 32-36 GW (13% more than the previous year).

With 17 GW shipped in the first half of the year, I see the lowest point of the guideline as achievablealthough this will depend heavily on macroeconomic developments and in particular on the direction interest rates will take from here.

Looking ahead, the consensus is calling for a miraculous recovery with 500% YoY growth by 2025. That would make the stock a no-brainer buy at a current forward P/E of just 4.4x. Unfortunately, this recovery is far from guaranteed.

Headwinds are likely to continue for some time

The solar market has suffered over the last 12-18 months, largely due to high interest rates. The reasoning here is that solar investments generally have a 20 year payback period, or analogously a 4% annual ROI. That may be attractive to many people in a low interest rate environment, especially when we look at the ever increasing cost of electricity, but when interest rates are 5%+ it’s simply not an attractive investment. As a result, the demand for solar panels for both residential and industrial use has plummeted.

Today, interest rates seem destined to fall with at least one certain cut of 25 bps in September. And probably cuts of 100 bps by the end of the year.

But the Fed’s dot plot assumes a gradual decline in interest rates after this year. And a faster decline in rates would likely only happen if we have a recession, which would be just as bad for the solar market as high rates.

Therefore, I don’t expect the solar panel market to recover quickly.

Too cheap to ignore

I expect CSIQ to struggle to deliver significant positive earnings in 2024 and 2025, but at the same time I see a lot of potential beyond that. (1) interest rates fall over time, and (2) we are working through the current economic uncertainty. In particular, there is a lot of potential for solar energy in the long term, as the technology continues to be heavily pushed by governments around the world as part of their green agenda.

It is impossible to pinpoint the exact moment when the bottom has been reached, but it is hard to deny that this is not a good time to invest in cyclical solar companies, as these companies are near their lowest levels in the last decade.

In the case of Canadian Solar, the buy thesis is strengthened by the fact that the Canada-based company is still trading at only a fraction of the value of its stake in subsidiary CSI Solar Co. The subsidiary is traded on the Shanghai Stock Exchange with a market capitalization of 40 billion yuan, which is approximately $5.6 billion. Therefore, the 62% stake held by CSIQ is worth almost $3.5 billion, approximately four times more than CSIQ’s current market capitalization of $800 million.

While I recognize that there is increased risk with respect to China, which I discussed extensively in my previous article, I find it difficult to understand why the market has placed such a large discount on CSIQ. As a result, I continue to slowly accumulate shares at these decade low prices in an attempt to build a 1% position in the stock. I don’t expect the recovery to be as rapid as consensus predicts, but once the solar market gets going, I see significant triple-digit RoR potential.

That’s why I repeat my Spec buy rating for this high risk, high return investment.