2024-01-04 05:58:28 ET
Summary
- ARRY has underperformed its small-cap peers over the past year.
- Despite the weakness, we pick out multiple themes which suggest that things are not as bad as the market thinks.
- Given the earnings growth on offer, valuations look tasty.
- However, the charts still suggest that bearish conditions are yet to abate.
No Alpha For The Past Year
Over the past year, the stock of Array Technologies (ARRY), a manufacturer of integrated solar tracking systems, hasn't been a rewarding play for investors. Whilst its small-cap peers from the Russell 2000 have delivered ~16% returns during this period, ARRY has lost -12% of its value.
Still A Lot Of Good Developments
Despite the wealth erosion seen over the past year, we still feel there are a lot of encouraging developments that shouldn't make prospective investors view ARRY as a washout.
Much of the weakness has stemmed from revenue cuts for FY23. For context, when we first wrote about ARRY back in April last year, consensus was eyeing FY23 revenue of $1.89bn. However, by the publication of the Q3 results in November, management had cut expectations significantly, pointing to a FY range of only $1.52bn-$1.57bn . At the same, you have a scenario where the unearned revenue on the books had been sliding for 4 straight quarters, coming off by -44% in aggregate.
However, despite the unideal situation, it's important for investors to note that much of the revenue attrition for FY23 is not something that has been obliterated, but deferred to future periods, largely on account of regulatory uncertainty linked to the IRA , some permitting delays in Spain, and developer financing projects.
What's crucial to note is that amidst all this, the company has not seen any project cancellations whatsoever, and rather the domestic project pipeline has actually doubled between Q2 and Q3.
Now, in mid-December , we saw the Department of Treasury come out with further guidance on the advanced manufacturing production credit, linked to the IRA, which should help clear up some of the impasse seen in recent periods, although the public hearing on this proposed regulation will take place only by Feb 22nd. ARRY management had suggested that roughly $285m-$300m of IRA-related projects were put on hold on account of this, awaiting regulatory clarity.
Developer financing challenges too could likely abate with the Fed poised to cut rates 6 times (by 25bps on each occasion) next year, and the Spanish projects were anyway poised to come online by the beginning of FY24. All in all, if one looks at revenue estimates for the next two years, you're looking at fairly sturdy topline CAGR of 21%.
In spite of the topline challenges, investors should also consider that ARRY has been making tremendous gross margin progress in recent quarters, with margins now at the pre-pandemic levels. Crucially, note that this has come about without the prospective benefit of the 45x manufacturing credits. Gross margin progression could be abetted even further on account of ARRY's recent impetus in non-tracker revenue streams such as aftermarket initiatives, change order capture, engineering offerings, and smart track monetization.
At the operating level, ARRY has also been seeing benefits on the logistics and material front, and this has helped bring down the OPEX cost base quite significantly from what was seen at the start of 2023.
Also note that after a difficult few quarters, until Q2-22, ARRY has now been generating consistent positive operating cash flow for the last 5 quarters. In effect, the ARRY stock which has largely yielded negative FCF yield (-2.3% is the 5-year average) is currently offering a hefty FCF yield figure of high single digits. Expect this to stay resilient as after delivering $126m of positive FCF for the first 9 months of 2023, management believes they could well hit levels of $150m-200m for the whole year, implying anything between $25m-$75m in Q4.
Strong FCF generation also means that the company has been able to pay down significant debt, with the quantum of debt paydown per quarter picking up sequentially and taking the company closer to its net leverage ratio target of 2x .
For context Note that Array Tech's net debt paydown yield, which measures the change in total debt paid relative to the market cap, has this year hit positive levels for the first time since Q3-21.
Forward Valuations Look Attractive
ARRY's forward valuations don't come across as expensive either. The stock is currently priced at only 12.5x forward P/E, and at that multiple you get a tremendous amount of earnings growth through the next two years.
Basically consensus numbers point to earnings growth of 31-32%, not just for the coming year, but next year as well. Put another way, you're looking at a business priced at a forward PEG ratio of only around 0.4x!
Closing Thoughts- The Technicals Don't Support A Long Position As Yet
Whilst there are a lot of factors supporting a long play in ARRY, the charts still suggest that it may be too soon to jump in. Basically, there are still doubts over whether the bearish tilt has abated, and we would need to see the stock defend its pivot low before we can be sure of turning more constructive.
ARRY's weekly movements from August 2022 to mid-Oct 2023 show us that the stock's movements took the form of a rising wedge pattern. In October we saw a breakdown from the lower boundary of the wedge, carrying on a downtrend which had kicked off since mid-September 2023.
If we take a step back and follow the price imprints since mid-September it looks like the price is now following the bearish flag pattern, and after a pullback near the edge of the old wedge boundary, we've seen that the stock has been unable to kick on and move back to the wedge, and rather, a second bout of selling appears to have recommenced. The next test will be to see if ARRY can defend its pivot low of sub $14 levels.
Note that the percentage of float that is short is now at elevated levels of 16.7%, the highest in over a year, and it's not as if the days to cover (at less than 5 days) is particularly large to facilitate ample short-covering momentum
The other point to also consider is that segment with ample clout- the institutional club, has continued to reduce their stake in ARRY through Q4-23, which is not a good sign when you're counting on some bargain-hunting support.
The conviction to go long at cheap valuations is further dampened by what the relative strength charts are suggesting. Investors looking for suitable mean-reversion opportunities in the clean energy space, may not quite gravitate to ARRY as its relative strength ratio is now trading well above the mid-point of its long-term range.
All things considered, a HOLD rating feels suitable.
For further details see:
Array Technologies: A Lot Of Tailwinds, But The Charts Are Not Yet On Board