Canadian Solar has been a big winner for investors over the past two years as demand for solar panels has increased and the company transitioned to building large solar projects. But will this remain a winning strategy for the future? Here are a few risks to watch out for.
Will margins plunge in 2015?
It's no coincidence that Canadian Solar's stock rise has coincided with its move into building projects. When it started constructing projects in Canada it was one of the only companies that could build enough solar panels locally to qualify to bid, meaning it secured much higher than market prices for projects built in late 2013 and 2014. But the Canadian government realized it was not getting competitive prices and changed the bidding restrictions, resulting in Canadian Solar last year not adding a single project to its backlog in the country.
The impact on margins and profits in 2015 could be huge. In the fourth quarter, the company sold 50 megawatts of projects for C$311 million (C$6.22 per watt); the backlog now stands at C$900 million for 275.6 MW of projects (C$3.27).
Canadian Solar does not break out margins for the project business; but considering the industry average cost per watt of $1.55, or C$1.96, it's easy to see that projects were likely sold for a gross margin well in excess of 50% last year. In 2015, margins will fall dramatically, which could sink profits. That could make the stock's P/E ratio of 8.3 look cheaper than it really is.
No technological differentiation
The other challenge I see for Canadian Solar is that nothing really differentiates the company technologically. It makes a fairly standard solar panel that is largely similar to those from other Chinese manufacturers.
Its most efficient panel is 16.79% efficient, which is well behind the 21.5% efficient panel from SunPower . Most Canadian Solar panels are 15% to 16% efficient, which might be better than products from some suppliers but isn't fundamentally different than commodity panels made by Trina Solar , Yingli Green Energy , JinkoSolar , or any number of other manufacturers.
As solar companies lower costs I think efficiency and technology will play a growing role in the industry. Successful companies will offer something that adds to the value proposition of solar, such as higher efficiently, lower degradation, or energy storage. Canadian Solar doesn't offer that, which is a concern for me.
There is good news
I've highlighted some of the negatives for Canadian Solar going forward, but there is good news as well. Solar demand is booming and there's likely to be a shortage of solar panels in the next few years. That means panel prices, which have plunged in the last five years alone, could actually rise.
The U.S. Solar Market Insight Report 2014, from GTM Research and the Solar Energy Industries Association, showed panel prices in the U.S. rose a penny per watt over the last twelve months to $0.73. That resulted from higher demand and increased tariffs on imports.
But higher prices didn't dampen demand. Solar installations grew 30% to 6.2 GW last year in the U.S., and they are expected to grow another 31% to 8.1 GW in 2015. Globally, installations could grow 25% to 57 GW.
The increase in demand and Canadian Solar increasing production to 4.0 GW-4.3 GW could power profit growth on the panel side that could be sustainable for years to come. Project builders used to have their choice of solar panels from manufacturers desperate to sell inventory, but the balance is shifting to solar manufacturers. With such large capacity, Canadian Solar should be a big winner.
Is Canadian Solar a buy?
Canadian Solar looks like a steal today with a P/E ratio of 8.3, but that could be misleading. The company will face lower margins and potentially lower profits in 2015 because it won't have high-margin Canadian projects to rely on.
We're already starting to see evidence of the impact. Gross margin fell from 22.9% in third-quarter 2014 to 19.3% in the fourth quarter, and is expected to dip lower to 16%-18% in the first quarter of 2015.
Combined with the fact that Canadian Solar is really a commodity manufacturer, I don't see any reason to buy this stock over company that can offer differentiation, such as SunPower, First Solar, or even SolarCity, which is building a high-efficiency solar manufacturing plant.
I don't think this stock is a buy, and investors will be in for a weaker 2015 than they expect right now.
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The article Is Canadian Solar Inc.'s Stock a Buy? originally appeared on Fool.com.
Travis Hoium owns shares of SunPower. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
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