2023-04-18 12:42:45 ET
Summary
- The STI Norland acquisition should help derisk the business and expose Array to a promising Brazilian landscape.
- Lack of ample regulatory clarity is keeping a lid on the stock’s prospects, although valuations are not particularly cheap.
- ARRY suffers from flawed internal controls and Q1 could be a subdued quarter.
Introduction
Array Technologies, Inc. ( ARRY ) specializes in ground-mounting single-axis tracking systems used in solar energy projects at utility scale. Compared to fixed-tilt mounting systems, the solar trackers of ARRY can play a pivotal role in enhancing energy production as they help the solar panels to move in tandem with the sun's movement across the sky. ARRY's target market is primarily oriented toward solar-based EPC firms (Engineering, Procurement, and Construction), although it also sells its products to independent power producers, large solar developers, and utilities.
We are currently neutral on ARRY but here’s what we like about the story.
STI acquisition offers useful diversification
Array is a pretty big name in the US solar tracker market, but there was the risk of the company getting too unidimensional. In that regard, the acquisition of STI Norland last year should help bring some useful diversification. Firstly, it gives ARRY additional manufacturing and warehousing footprint of over 750k square feet in Europe and Latin America (in addition to ARRY’s core operations in New Mexico).
Crucially the acquisition gives ARRY solid exposure to the Brazilian solar market (STI is #1 there) where things appear to look very promising under the new Lula regime . Solar is currently the third-largest component of Brazil's energy mix at 21GW, and this is poised to more than double to 45GW by the end of this decade.
Investors should also note that effective solar tracker installations depend a lot on the weather. During colder months in the Northern Hemisphere where the ground is typically frozen, installations can be less cost-effective and tend to weigh on North American volumes. This seasonality effect could likely be negated by ARRY's growing presence in the Brazilian market and other markets in the Southern Hemisphere.
FCF prowess picking up
A useful hallmark of gauging a company’s maturity in the overall lifecycle is when you start witnessing positive free cash flow ((FCF)) generation on a consistent basis. After six straight quarters of negative FCF, ARRY has managed to turn things around generating an aggregate of close to $200m worth of FCF in Q3, and Q4 of 2022. Some of the FCF improvement has come from better gross margin dynamics which are now back to double-digit levels but there have also been useful improvements on the working capital front with the cash conversion cycle coming down significantly by over 30%.
In effect, a business that was not yielding any FCF for years, is now yielding FCF of close to +4% at the current market cap! The FCF yield is likely to stay positive for the foreseeable future, as the company intends to generate over $100m of FCF in FY23.
Regulatory catalysts on the anvil
If one looks at ARRY's stock price imprints on the weekly chart, we can see that it has recently been forming something akin to an ascending triangle pattern . Over many weeks now the stock has been building a base just below its sloping resistance without quite breaking out, much like a coiled spring.
I believe this state of limbo could come to an end once the Treasury Department comes out with further clarifications on various clauses in the IRA. Firstly, there’s a lot of doubt over what constitutes domestic content under the IRA, prompting clients to stay on the sidelines. Secondly, there's also a lot of ambiguity surrounding the timing of application for manufacturing credits. If these issues get cleared up, it would help tilt sentiment toward the stock as its order book could potentially surge and profitability forecasts could be tilted higher.
A Few Concerns
Whilst there are some promising undertones surrounding Array Technologies, we also thought it would be worth highlighting a few unfavorable narratives which investors ought to be mindful of.
Flawed internal controls may kickstart a trust deficit
ARRY management recently admitted that there were material weaknesses in their internal controls over the financial reporting in FY22. Much of these issues are linked to the STI Norland acquisition . Basically, the goodwill and intangible assets acquired were not recorded at appropriate amounts, nor were they linked to the appropriate entities, or maintained in the appropriate currencies. Besides, ARRY also resorted to capitalizing an asset rather than expensing it as incurred. These may well be one-off incidents, but developments of this sort don’t reflect well on the management’s credibility, and it may prompt certain investors to think twice about getting on board with ARRY.
Near-term outlook to be subdued
Investors who are looking to get in should also consider that ARRY may continue to be adversely affected by module availability challenges. Besides from a seasonality angle, Q1 is also the weakest quarter for ARRY. All in all, Q1 revenues look poised to decline by 20% from the Q4 levels of $402m (this implies subdued Q1 sales of just $335m, although sell-side analysts have it a lot lower at $325m).
Pricey, and limited incentive to rotate within the clean energy space
As far as forward valuations go, it’s fair to say that ARRY doesn’t offer the best value at this price point. Based on the FY24 sales estimates , the stock currently trades at a forward multiple of 1.47x, a premium of 24% over the stock’s long-term average.
Sure, prima facie, a few readers may suggest that a P/S of less than 1.5x is hardly exorbitant but do consider that ARRY’s close solar tracker peer- Nextracker Inc ( NXT ), only trades at 0.71x forward P/S. NXT's multiple looks even more compelling given that its sales are poised to grow at a 3-year CAGR of 21% , better than ARRY’s expected sales 3-year CAGR of 17% !
The chart above shows how ARRY's stock is positioned relative to its clean-energy peers. A year ago, ARRY could have worked as a fine mean-reversion candidate in the clean energy space, as the relative strength ratio looked overextended to the downside. That is no longer the case with the ratio now trading above the mid-point of its range.
For further details see:
Array Technologies: What's Favorable, And What's Not