According to Citigroup, checks suggest pricing in its highly leveraged semi business has reached a key inflection and it is starting to reap meaningful cost reductions in its poly operations. While solar poly prices should remain under pressure through 2H:09, this has become broad consensus, meaning stock will move well before poly price increases occur (likely in mid-2010). F2009 from $0.16 to $0.34, F2010 from ~$1 to $1.34 and tgt $15 to $24 on ~15x C2010e + cash. See ~$12-13 replacement value for WFR’s assets or just 20% downside.
- Pricing headwinds starting to ease — Checks suggest 300mm wafer price of ~$90 (down from ~$125 entering ’09) now near all-in cash cost of ~$80-85 finally driving some supply rationalization + price inflection. They estimate WFR’s solar biz is run-rating EPS ~$0.60-0.80/yr despite poly pricing pressure, so all we need is for semis to stop losing money and a better semi pricing environment + supply rationalization should key this move.
- Near-term solar remains tough, but results solid and WFR as well positioned structurally as FSLR — Citigroup sees FQ2:09 (Jun) results at least in-line and likely better while margins at module makers have yet to bottom. They remain cautious on solar, but they think the Street will increasingly see a story here where sustainable margins and returns for WFR are similar to FSLR at a fraction of the multiple. Additionally, while it is taking some time, WFR is working with solar contract customers to extract concessions that may enable an asset-lite move downstream that would drive lower project IRR and share gain.
Additionally, one might expect poly prices to come down further in reaction to recently plummeting module prices. Indeed, firm's work on poly and module prices shows that module prices have generally led poly price declines. While this is a risk, it is quite simply consensus and even if it were to occur, the firm estimates WFR would still make ~$0.10/Q in each of CQ3 and CQ4.
As Street numbers have continued to march lower, Citigroup has been building a case that they wanted to get more positive on the solar sector at some point in 2H:09. While they don’t think it warrants that broad call yet, they feel WFR certainly has the best leverage of any mainstream solar play and they can make a structural case that is in the same ballpark as FSLR in terms of its flexibility and ability to gain share over time with a combination of cost advantages and sustainable cash flow. To that end, WFR is in the unique position of being able to fund continued poly capacity expansion from current cash flow (estimate it is run-rating ~$0.60-0.80/yr in the solar business) and all we need is a better semi pricing environment to lift some of the drag on overall earnings of the company.
One can build a case that sustainable gross margins are similar to FSLR
Over the longer term, WFR’s superior balance sheet versus its poly peers provides significant financial flexibility as it starts to create value downstream and take market share. To see this, Citigroup uses the example of a downstream module provider buying wafers at markup and selling modules into a project as compared to WFR selling in at cost. It is hard for them to see a sustainable situation where poly would sell for <$50/kg since broad grid parity is achievable in most regions at the $2.25-2.50 installed cost level. Assuming balance of system of ~$1.00 this means modules can sell in the $1.25-1.50 range sustainably. World-class non-silicon costs are already in the ~$0.65-0.70 range which, assuming module providers – which are basically just like EMS companies – are willing to take 10-15% gross margins long term, this leaves ~$0.50-0.60 for the wafer. Assuming tolling costs come down to ~$0.25-0.30 which even seems high, this leaves ~$0.25-0.30/W for the wafer. At ~5-6g/W this implies a poly cost of ~$50-60/kg. So, if WFR can make poly for ~$30/kg and sell it for $50-60 this implies sustainable gross margin in the 40-50% range, or not dissimilar to FSLR.
Notablecalls: Certainly an interesting call from the Citigroup Semiconductor Equipment team. Note the call comes only two weeks after JP Morgan downgraded the stock to Underweight (see archives) saying more and more poly capacity is coming online.
The whole WFR situation kind of likens to what the DRAM industry experienced over the past couple of years as Asian players kept adding capacity pushing gross margins to negative (!) range. While I'm not sure we will see negative GM's in this space, Citi may be somewhat early with their bottoming call. These things tend to take time.
So while the upgrade looks groovy and will probably work in the short-term (I'm guessing 5-6% upside today), I'm not entirely sure WFR warrants an investment here.