Thursday, January 31, 2013

Sevcon ( Nasdaq - SEV ) -- Better Days Ahead

Sevcon (SEV $3.75) reported lower than expected Q1 (Dec.) results.  Sales dropped 22% to $6.64 million.  Earnings slid to a loss of $.39 a share.  Sevcon is a leading provider of controls for electric vehicle engines.  In general, half the business is directed towards off-road work machines.  The rest is used in small city cars, motorcycles, and all terrain recreational vehicles.  Both segments were hit hard in the latest quarter, continuing a slowdown that began earlier in 2012.  European volume nosedived 44% due both to the poor economy and a break in production by Renault of its promising city car line.  U.S. volume declined 18%, mainly due to the election.  The Obama Administration implemented stringent E.P.A. rules that will force a large increase in electric work machines.  Producers of those fork lift trucks and other vehicles delayed implementation, hoping Mitt Romney would be elected and moderate the impact.  Asian demand picked up by 17%, but that represents a small part of the business currently.

Work machine volume is poised to accelerate over the next 3-5 years.  E.P.A. regulations that go into effect in 2015 and 2017 will require less pollution and greater fuel efficiency.  Sevcon is working on a number of programs, mainly in the hybrid engine area.  The electric car segment promises to recover, as well.  Renault built a limited number of city cars to begin with in 2012.  Demand was strong.  Bigger production volumes are slated to begin in March.  Motorcycle and ATV demand has been consistent.

The long term outlook remains positive.  Electric vehicles will remain a niche segment until improved battery technology expands their range.  That's not on the horizon.  But there are millions of short range commercial, industrial, and consumer vehicles that are candidates for hybrid and electric engines.  The share count is low. So any meaningful improvement could support substantial stock price appreciation.

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Tuesday, January 22, 2013

Power One ( Nasdaq - PWER ) -- Malaise de Europe

Power One (PWER $4.00) appears on track to report lower than expected Q4 results.  The company is the second largest producer of string converters that turn DC power generated by solar panels into AC electricity.  Demand declined dramatically in Q4 following the elimination of key subsidies in Italy and Germany.  Other European nations have imposed reductions, as well.  U.S. business remains good.  Accelerated depreciation rules, federal tax credits, and a range of state and local programs have kept the residential and light commercial segments expanding at a fast pace.  But large installations, which account for half the American market, have slowed due to the recession and more efficient energy use.  Financial performance is likely to fall short of previous targets in the December quarter.  Sluggish results could persist well into 2013 as European declines erase whatever upturn Power One benefits from in the U.S.  Asian solar installations are on the rise.  But those projects are tough to crack due to protectionist schemes.

The long term outlook is uncertain.  U.S. subsidies are scheduled to end in 2016.  Tariff wars are cropping up, making it difficult to serve the entire world solar market.  Europe remains depressed, making it unlikely new government subsidies will emerge any time soon.  On the plus side inverter production costs keep coming down.  New products are in the pipeline.  And the cost of solar systems in general remains on a favorable slope, laying the groundwork for broad based adoption over the long haul.

2013 is likely to be a transition year for Power One.  The company is well financed, though.  And its new product pipeline promises to reinforce Power One's competitive position.  Earnings could rebound in 2014, perhaps bolstered by new U.S. government support.  Natural gas remains a huge challenge to the industry.  That lower cost and less polluting fossil fuel has displaced home heating oil and coal over the past five years, lowering co-2 emissions in the United States by 10% over that time.  The lack of electricity demand growth presents another obstacle.  More efficient appliances and lighting have helped keep electricity demand flat in the U.S. despite fast growth in the number of electrical devices.  If total electricity output doesn't improve solar probably will expand less rapidly than predicted.

Long term appreciation is possible in spite of the headwinds.  If the world economy returns to normal and trade obstacles are not created, Power One could rebuild earnings to the $.50-$1.00 a share range within 2-3 years.

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GT Advanced Technology ( Nasdaq - GTAT ) -- Backlog Vanishes

GT Advanced Technology appears on track to report poor Q4 results.  The company is the leading provider of capital equipment for the solar industry.  One set of machines produces polysilicon.  Another converts that into solar cells.  Assembly operations performed by other companies, primarily in the Far East, combine those cells into panels.  GT Advanced entered 2012 with a billion dollar backlog.  Oversupply conditions in the solar industry, brought about by sharply reduced government subsidies in Europe, caused incoming orders to dry up.  The company continued to recognize decent revenues earlier in the year from equipment that already had been delivered and was awaiting final customer acceptance.  New shipments took a nosedive.  And that trend is unlikely to reverse before late 2013.  Low revenues are likely to yield an operating loss in the December period.  A large inventory writedown is anticipated, as well.

A next generation technology is slated for introduction in mid-2013.  That will be a modular add-on unit with a selling price far below that of a complete system.  The new "mono-silicon" approach promises a significant improvement in solar cell performance at a comparable cost to "poly-silicon."  The Far East solar industry is in the midst of a consolidation, however, so few orders are expected right away.  Financing remains hard to obtain and profit margins still are under pressure.  Chinese government subsidies may cause the oversupply situation to persist by propping up weak participants as a vehicle to preserve jobs.  Orders for GT Advanced systems probably won't accelerate until the profit potential from its new machines improves.

The LED segment is under pressure, too.  GT Advanced encounters direct competition in that market.  LED lighting costs far more than conventional bulbs.  Consumer and commercial demand is rising, though.  The current lull in capital equipment orders is likely to end long before the solar industry rebounds.

Our estimates are below the company's official guidance.  GT Advanced predicts income of $.25-$.40 a share in 2013 on revenues of $500-$600 million.  Results could bounce back starting in 2014.  The company remains the only large volume producer of solar manufacturing systems.  Future results might be diluted 20% by a recent convertible bond issue ($7.71 a share).

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Monday, January 21, 2013

Real Goods Solar ( Nasdaq - RSOL ) -- Speculative Turnaround

Real Goods Solar (RSOL $0.85) appears on track to report unexceptional Q4 results.  New management was brought in during the third quarter.  The company's two largest shareholders each contributed $1.0 million in debt financing, as well, to tide things over while operations were straightened out.  Overdue receivables were collected, reinforcing cash flow.  Middle management was streamlined.  New marketing techniques have been developed.  And better supply arrangements were negotiated.  Still, the overhang from earlier mistakes almost certainly kept sales below potential.  Margins probably remained below normal, as well.  Another sizable loss is anticipated.

The solar installation industry is thriving, though.  If Real Goods Solar's new management team can restore operations to normal, profitability could reverse course in a meaningful way.  The company is a leading provider of solar systems for residential (50% of sales) and commercial (50%) customers.  The latter business was added early in 2012 via an acquisition.  The underlying business remains solid but too much bureaucracy was created by the merger.  Most residential contracts provide homeowners with electricity at prices below local utility costs with no upfront investment.  Real Goods Solar engineers and builds the systems, and then sells them to investors who benefit from a raft of tax benefits.  Homeowners either lease the systems and pay a fixed monthly amount.  Or they pay for the electricity they use, subject to a monthly minimum.  The format usually depends on what kind of buy-and-sell deals are available with the local utility.

U.S. tax credits offset 30% of a system's cost.  The law actually allows higher credits based on a "market value" formula, although that approach has been subject to abuse and now is being investigated by the government to identify possible fraud.  State and local governments provide additional payments.  And many utilities are forced to offer incentives of their own.  On top of that the I.R.S. permits 60% first year depreciation, and 100% after five years.  Low interest rates facilitate financing options further.  As a result installation companies like Real Goods Solar can sell systems at a hefty mark-up to the financing companies. The trick is to keep marketing, management, and regulatory costs to a minimum.

A large debt payment comes due next April.  Sales expansion is likely to be held back until that obligation is refinanced.  The bank is sure to require evidence that margins are returning to normal.  Despite that constraint on selling expense, sales promise to improve at an above average rate.  Panel costs continue to fall.  Installation methods have become increasingly efficient.  And the tax incentives will remain in place until 2016, if they aren't extended.  Climate change has been identified as a top priority by President Obama as he begins his second term.  Additional boosts could emerge.

We estimate Real Goods Solar will return to profitability this year.  In 2-3 years sales could reach $150-$200 million.  At 5% pretax margins fully taxed income could attain $.15-$.20 a share.  Higher margins appear possible, especially if the regulatory climate is simplified.  Obtaining permits and hook-ups now accounts for 25%-40% of a deal's total cost.  Aligning local utility interests with the solar industry could yield further benefits.  New solar technologies are in the pipeline which could double price performance of the panels themselves in 2-3 years.  That rate of improvement could be sustained for several iterations, making solar a mainstream technology.

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Sunday, January 20, 2013

Enphase Energy ( Nasdaq - ENPH ) -- Price Pressure Persists

Enphase Energy (ENPH $3.75) appears on track to report unexceptional Q4 results.  Enphase is the leading provider of microinverters that convert DC power generated by solar panels into AC electrical current.  Most of the solar industry uses string converters.  Those are large units that sit on the ground and convert an entire string of panels.  Microinverters are attached to each individual panel.  The string units are less expensive.  And their prices are declining quickly in response to engineering improvements and relentless competition.  Microinverters generate more electricity output, typically 10%-15% more.  String converters are limited by their worst performing panel.  If a single panel becomes impaired -- for instance by leaves, shadows, or debris --the entire system is affected.  Microinverteers enable each panel to produce at maximum output.  New financing arrangements in the U.S. residential solar market are encouraging system installers to emphasize price more than output.  Those schemes are cutting into Enphase's potential market, thwarting the company from growing as rapidly as it might.

A next generation product line could open up the commercial sector.  To date Enphase has serviced the residential market.  New systems slated for introduction early in 2013 promise to address the small commercial area.  Even larger units are planned for 2014.  Commercial building owners are likely to be more alert to the energy savings Enphase devices produce.  So even though lower initial prices for string converters will remain a competitive issue, acceptance could prove high.

Expansion outside the U.S. offers further potential.  Enphase concentrates on the U.S. market presently.  More than 90% of sales are to domestic customers.  Much of the rest is made in Canada.  New distribution channels are being developed to enter Europe and Asia.  The European market contracted markedly in 2012 due to the economic crisis, which caused subsidies to vanish.  Asian demand is picking up, although tariffs are on the rise to prevent imports.  Enphase is beginning from virtually a zero base, though, so at least some incremental benefit is likely.

We estimate 2012 earnings finished around minus $.80 a share.  Next year margins could improve as fixed costs are spread over a broader base, and direct costs are reduced consistent with selling price declines.  Our estimate is a loss of $.25 a share.  A move to profitability could occur in 2014.  The long term outlook remains uncertain.  U.S. tax subsidies equal to 30%-40% of a solar system's cost are scheduled to disappear in one fell swoop in 2016.  Further improvements in solar technology are likely to offset some of that.  But unless regulatory costs are brought down and electric utilities are given incentives to embrace solar, profitability might remain challenged well into the decade.

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