FSLR - Canadian Solar: Outlook Is Enticing

Summary

• Canadian Solar is a highly profitable company.
• The business has a hidden catalyst, which is the IPO of its smaller segment, CSI Solar.
• Canadian Solar will benefit from substantial tailwinds affecting the sector as a whole.

Investment Thesis

Canadian Solar ( CSIQ ) preannounced its preliminary Q4 results last Friday. Admittedly, its Q1 guidance didn't live up to analysts' expectations.

Also, there was no update on its carve-out IPO of the CSI Solar subsidiary.

But is this where the Canadian Solar story ends?

I don't believe that's the case. In fact, I continue to believe that there are two major tailwinds that will propel this company's prospects further, positive regulations and the need for rebuilding our modern grid infrastructure.

To be clear, the story is far from straightforward, but on balance, it's difficult not to be optimistic.

What's Happening Right Now?

The graphic above is a reminder that solar companies have not been bad places to hide in the past 3 months. Even without cherry-picking my data, all solar stocks have done just as well or better than S&P500 in the past 3 months. I'm sure you can add to this list two more names, that have done even better.

And indeed, as you know, First Solar ( FSLR ) has now reported its results and the one underperformer in the group is up at least 4% per market. Hence reinforcing the overall narrative, that there's ample demand for this sector.

Revenue Growth Rates, Tough Comparables Ahead

The guidance provided on Friday shows that Q1 revenues will be up approximately 40% y/y. Given that when Canadian Solar guided for Q1 it was already two months into the quarter, I believe we can practically bank on this revenue growth rate.

Of course, the next question that investors have to form a view on, is what sort of growth rates will the rest of 2023 have? Particularly starting with the most challenging comparable period, Q2 2023.

But there's more.

Prospects for 2023, Can CSI Solar Gross Margins Improve

Canadian Solar manufactures solar power products, including solar panels and solar power systems for power generation. It has two business units.

Here I've used the figures Canadian Solar's Q3 results, which are now slightly outdated. The reason for using this data is that Canadian Solar hasn't yet published its full Q4 results. These results will come at the end of this month. But I believe that for our purposes these figures work.

The graphic above is a reminder that CSI Solar makes up nearly the totality of its full business. This segment is made up of solar module manufacturing.

Moreover, recall that Canadian Solar is in the process of having a carve-out IPO of CSI Solar. Leaving Canadian Solar only with its energy storage projects.

Simply put, the bull case here is that as Canadian Solar's energy storage solutions continue to take market share, Canadian Solar can grow its scale, and drive improved gross margins profitability. Which, incidentally, is the topic of the next section.

Crucial Aspect Bulls Should Focus On

In last year's Q1, Canadian Solar's gross margins stood at 14.5%. While this time around Canadian Solar guides for approximately 19% at the midpoint. In other words, the guidance for Canadian Solar's upcoming quarter points to approximately 450 basis points of gross profit margin expansion compared with the prior year.

In actuality, recall that Q1 of last year saw a meager $0.14 in EPS. And this time around, the business is presumed to report more than $0.90 of EPS; a massive jump in profitability compared with the same period a year ago.

The Bottom Line

Canadian Solar is rapidly growing and profitable. Also, its valuation makes a lot of sense. By my very rough estimates, the stock is priced at less than 9x EPS.

The one concern that investors should keep in mind is that government-sponsored programs are indirectly boosting demand for solar panels. Hence, if this financial support is scaled back, it would weaken consumer demand, which would hurt Canadian Solar's ability to set prices.

The other aspect to remember is that Canadian Solar does not have a moat. It's in competition with countless companies, all with similar offerings.

But all together, I'm bullish on CSIQ.

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