After three profits warnings, a 60% share price decline over the past year and a new restructuring strategy, sentiment is still not yet likely to turn positive. Pricing pressure in the core market is there to stay. The company is well positioned to ship into a growing smart energy market, but it will encounter new and strong competitors. Consensus is still too high.
The share price of SMA Solar has fallen 85% peak to trough and is now standing at a new all-time low. The EV/Ebitda multiple has contracted from 6.4x to 4.5x. The next points shed some light on bull and bear points.
SMA has delivered profits warning number three. That concerns 2014 and 2015. Reduced guidance is now for a 2014 net loss of EUR 115m and a net loss of Eur 30-60m for 2015. This is on 2015 revenues of Eur 730-770m.
Management quotes generally difficult markets, weak German and European demand, competition and pricing pressure.
None of these issues are new. The issue is that the company has long time communicated a message that was meant to dissociate SMA from all of the broader market problems and differentiate from the sector. Fundamentally, the building blocks of that messages are there: Strong brand equity, market leadership in a fragmented market, and a flexible cost structure.
The big question – it has encountered doubt in the market before – is barriers to entry. That is the very centre of SMA’s problems. The company communicates a strong claim of barriers to entry, through its market position and through IP.
I agree that SMA’s product has IP and differentiating features. But, inverters in its very basic form are undifferentiated products. SMA is coming to discover that. The announcement that the company will manufacture very basic version of its inverters as a response to Asian competitors is admission of the fact. Inverters in a simple form exist en masse and at very low prices. I do see it as a positive sign that management no longer insists that its basic inverter has great features of differentiation. That should open perspectives for strategic action.
High quality inverters improve performance of solar systems and also play an important part in bankability of an overall system or project. That has initially played in SMA’s favour. But, competitors have moved up the scale and SMA’s ability to differentiate has decreased, leaving the price point more vulnerable.
Management is now addressing the cost vs differentiation issue through the modular strategy where it tags higher value added components onto a basic inverter. That latter element clearly targets low cost competition: SMA is looking to manufacture as a low cost component.
SMA’s li-ion inverter and lead battery and storage packages are still priced at the high end of the market. The domestic version retails at Eur 13-15k including modules, of which I estimate an implied battery ASP of Eur 6-8K for the 2.2kW battery. On a stand-alone basis, SMA’s battery retails for Eur 5K. Average retail prices are at the Eur 8-11K level for 5-7kW batteries. The relationship is similar for the 4kW battery.
As a whole, the end price of the combined product fall. The basic inverter should trade on a very small implied premium vs low cost competition. By implication, the value added components will be the crucial margin drivers for SMA.
With that proposition, SMA’s case is conditioned on market take up of smart features, growth of storage, demand management and the like. It is also partly conditioned upon the company’s ability to develop that market.
SMA enters into a new marketplace, with new competitors. Its new competitors are battery manufacturers, appliance manufacturers and consumer and energy services companies. Do not forget Google – it is everywhere, and is developing an aggressive energy strategy for precisely the above new energy features.
SMA would be well advised to consider partnerships in those areas, particularly downstream towards customer management, packaged goods and services and broader relationships.
The other side of the equation, the cost base, is despite great flexibility (3 shift flexibility allows capacity to be flexed by a factor in excess of three) is not adequate yet. Inverter production is highly automated and materials account for 80-85% of total costs. But the remainder of labour can make a competitive difference. And, likely, there are material cost and working capital issues that need to be addressed, too.
I have argued for long time that there will be structural and persistent cost pressure across the solar value chain. That comes from its technology driven cost progress and price decline logic, and from the need to reduce costs in order to achieve grid parity. Now that grid parity has taken another step down with lower oil prices, solar has yet more pressure. Balance of system, ie inverters, bear the brunt. The sector has held up margins much longer than any other segment of the value chain. It has to deliver now.
SMA’s cost base is still too high and too fixed. Its former high margin markets are no longer the global demand drivers.
The internationalization strategy has worked to a degree. The company claims a 30% market share in the US. In terms of revenue and earnings contribution, the US accounts for c 40%. But, the company has hardly any presence in Japan, one of the most important growth markets. There initial inroads, but not strong enough for them to be a major turnaround driver yet. China seems closed to SMA, despite the Zeversol acquisition.
Management seems to be going back to its roots in a way: It is looking to adapt in such a way that it can make a profit with less than Eur 700m of revenues. The CEO quotes 2008 as the benchmark year. That is a return to the times before the great boom. In 2008, The SMA’s net earnings amounted to Eur 167m on Eur 680m revenues. But, at that time, its market position was that of an undisputed leader in the world’s largest solar market by a distance. The world has changed and with it margins. The company’s gross margin has halved. Future revenues are coming in at lower gross margins than those of 2008. The company’s cost base has to go below that of the pre-boom times.
Sentiment had seen a short blip up after the strategic announcements of the capital markets day. But consensus movement is firmly on the negative side and I see further pressure. Current consensus for 2015 is for Eur 852m of revenues, but for a net loss of Eur 20m, well above the low end of guidance. There could be big upside if management can deliver on its return to profit. So far, the market is not giving any credit for that. The earliest it might do is in my view from H2 when the first impact of any successful execution on the strategic plans could come through.
SMA trades on an EV/Ebitda multiple of 4.5x 2015E. That compares to an average of 4.6x for the global solar manufacturers and 8-9x for the recovery driven electronic and engineering competitors. For 2016, the first year where consensus is for a profit, the shares are trading on a P/E multiple of 25x. That is a growth stock multiple and in excess of the company’s historic peak multiple of 18.6x. I do not see room for multiple expansion. Rather, there is downside risk as the underlying numbers will come down and SMA is a later stage than most of the solar peers that have already gone through restructuring.
I estimate a fair value between Eur 9.50 and Eur 12.0. The high end would require to sustain a competitive advantage and grow ahead of the market until about 2030, whereas the low end implies a business that will be somewhat greater in scale but much resemble the 2008 levels. I expect ROIC will not recover to peak levels ever.