SMA Solar’s dramatic outlook revision seems more like a political cry for help to save the German solar industry than a declaration of fundamental transformation of its markets due to new technology or competition.
Granted, the on-going PV industrial revolution is a relentless challenge for all. But that’s not new. Inverter ASPs have been falling, down 14% in 2011 and possibly a further 10-15% in 2012. Our previous article about SMA pointed to the company’s strong management, balance sheet, geographical spread, flexible cost base, leading market share – all important factors that explain its survival and leadership in this context.
We wrote that we were hopeful about revenue generation in Q1 2012, given the surge of PV installations in SMA’s home market, Germany, last December, and claims by Power One that many of those installations were not equipped with inverters (“at least not yet” was the implication).
Then, to everyone’s surprise, on March 2nd SMA published a daunting warning for 2012: no visibility, a fall in sales to 1.2bn-1.5bn€, and Ebit margin to 5-10%. This is a giant spread and also a big decline from 2011 and 2010 when sales were 1.7bn€ /1.9bn€ and Ebit nearly 17%/27% in those respective years. Brokers immediately cut their forecasts and share price targets tumbled–Citibank from 42 to 22€ and Goldman Sachs from 40 to 34€.
The title of the warning statement hints of a political appeal: “Future Outlook is Impacted by Radical Reduction in Feed-in Tariffs in Germany.” It puts the blame on Germany’s new FIT cuts (effective April 1st) The text explains the damaging effects for utility-scale solar project development, a market segment in which SMA has been winning market share and margins are good.
Citibank changed its recommendation to ‘sell’ and commented: “Changes to German Feed-in-Tariffs (FITs) are likely to reduce German domestic IRRs to low single digits at best, and effectively stop any demand from large-scale projects. This could reduce the German market from 7.5GW in 2011 to 3.5GW, at best, in 2012, a reduction in demand that is unlikely to be made up by other countries.”
The second surprise came just two weeks later on March 16th. Solar installations in Germany are soaring–witness 3GW from January to March, and now forecast to be 4GW for H1 alone. This is above the new government target of 2.5-3GW. While we cannot infer from this that installations are being equipped with SMA inverters, or that installations will not fall off a cliff in H2 following the implementation of tariff cuts, we can conclude that installation forecasts like Citibank’s (3.5GW for FY12) are already too low.
The key question for investors must be: Should SMA’s revised numbers be interpreted as a secular trend change in its business that will reduce margins by 75% beyond 2012? We see no such change, particularly as the group becomes less Germany-focused.
In fact, we would argue that a 5% Ebit margin is too low going forward, given the value added in SMA Solar products and its leadership position. Two distinguishing features of its long-term strategy have been heavy investment in R&D (400 staff in 2010 and a further 100M€ budget just announced on March 2nd) and aggressive, regular expansion into foreign distribution and service networks. For example, in 2012 more staff are being added to India and first-time offices are being opened in South Africa and Chile. Price pressure is an on-going trend which SMA offsets by reducing costs (component costs targeted in 2012).
At worst, a 10-12% Ebit margin could be a sustainable level. Our assumptions include: further price pressure, constant technology upgrades (Sunny Central cuts system costs by 30%) and most important, installation growth beyond Germany and EU to improve margin, in newer markets, particularly Japan, the US, Africa, and South America. We disagree with Citi’s claim that Germany will not be replaced by other geographic markets. The ‘warning’ statement mentions an international sales target of 80%.
What then is the right price for SMA Solar, if it is sustainably generating a 10-12% Ebit margin? At 35€ the EV/Ebit multiples based on SMA’s 2012 Ebit forecast spread of 60M€ (‘worst case’) – 150M€ and an EV of 820M€ (including 400M€ net cash) is 13.6x–5.5x. Taking a mid-way Ebit of 105M€ gives a multiple of 7.8x.
Paying a multiple of 8x for a capital goods leader with all the qualities of SMA Solar seems reasonable to us particularly with such weak business assumptions.
By keeping its R&D going in difficult times, SMA is helping to find technological breakthroughs that make solar competitive with hydrocarbons without any subsidies at all.