| | | | | Neutral (Price target US$7.00) | | UBS Research THESIS MAP | a guide to our thinking and what's where in this report | | | Q: Can SPWR Offset the Oversupply Environment? Not enough. While there are some mitigating factors (dealer networks, three market segments etc), we think the drastic price decline this year has been too much for SPWR to handle. The mitigation techniques the company is employing may stem the tide, but we believe they are also reducing longer term profitability potential. more→ Q: Is restructuring enough to offset the downturn? Though the restructuring is a solid step towards longer term profitability, we view it as more of a necessary process than a significant offset of the industry issues. Ultimately, we believe SPWR could make it through this downturn just like the last, but the strategies to do so (idling producing, moving away from leases, and selling projects early) are lowering profitability. Q: Do we have visibility to EBITDA growth? No. Management guidance has so far been relatively unreliable (initial 2016 guidance provided one year ago has been cut 60%, while 2017 guidance was retracted on the Q3 call). While we laid out a potential pathway towards 2018+ growth and we still view that as valid, we simply do not have confidence in EBITDA generation pathway, given the extremely challenging macro environment. | | While SPWR still has a number of offsetting factors in the business that will help it weather the downturn, we see continued risk from anti-renewable knock on effects from the US election coupled with an oversupply environment where SPWR would be hard pressed to maintain margins across the business. We expect the company's mitigating factors to help it weather the downturn, but see limited prospects for a meaningful recovery in the near to medium term. | | While the company prices on a premium to other panels, margins are inherently dependent on commodity price concerns, and 25% ASP reduction in the last several months referenced on the call is one of the most substantial price declines ever seen in the industry. | | Based on our conversations with investors, near zero margins in the power plant segment appear largely assumed as fact at this point, whereas the latest leg down was driven partly be election risk and partly concerns on the DG business – long viewed as a bulwark against declining power plant margins. | | 
more→ | | SunPower is one of the leading global solar solutions providers for residential, commercial, and power plant customers by offering solar module technology and solar power systems.... more → |
SPWR Suspends 2017 GuidanceUpdating implied 2017 guidance, we look to $350-400M EBITDA as the base comparison on the next call. We suspect actual guidance will disappoint. In Q2, the company provided some preliminary 2017 guidance, seeing $300-400M of EBITDA, which would have implied a ~17% increase over 2016 EBITDA guidance at the time of $275 to 325 (this was also lowered to $185 to $210M). Best case scenario ahead of 2017 guide, that lost ~$100M in EBITDA for 2016 was pushed to 2017, but we do not expect at 1 to 1 conversion – much of the pushout appears to be commercial projects, which have trended in the mid to high single digit gross margin. The company's previous Q2 call pointed to resi and commercial segments as offsetting largely near-zero power plant margins, so increased concerns at the DG level are hardly encouraging. Even if we assume all of the ~75MW of commercial (from the reduced guidance below) were to be monetized for a generous ~$2.50/w, the company would need to generate an EBITDA margin of 53% to make up for the lost EBITDA. Instead, we imagine there would be a lesser amount recognized, in the ~50M EBITDA range. The key question now is how much the implied guidance will change. While previous 2017 guidance of $300-400M EBITDA did not include these commercial MW, we note true implied guidance is closer to $390-515M if we simply shift the guidance reduction this quarter into 2017. Perhaps a more realistic estimate to compare new 2017 guidance to is a bit lower, in the $350-400M range. Recap of the most recent guidance cut (in MW) Residential: Old: 350-450 / New: 320-330 Commercial: Old: 350-450 / 275-285 Power Plant: Old: 700-800 / 730-740 Echoes of the Analyst Day: Guidance is UnreliableIn Nov 2015, SPWR suggested that EBITDA would grow more linear from 2017 to 2020, where 2020 guidance was 'approximately double' 2015 EBITDA, which was at a midpoint of 488 at the time, implying nearly $1B of EBITDA in 2020 and presumably a number somewhat in line with 2016 EBITDA for 2017 – we originally estimated between $500-600M based on these disclosures. We compare this now to actual 2015 results of $557M (due to project pulls into 2015), and updated projections of $185 to $210M. In short, for SPWR to meet its 2020 guidance provided 1 year ago, we estimate the company would need to more than quadruple 2016 actual results – during a year when solar installations are on track to reach the highest ever by a far margin. While the supply/demand has undoubtedly deteriorated faster than anyone expected, we see this dramatic difference in EBITDA projection as a recognition of the extreme difficulty in forecasting these metrics, and the reliability of company metrics for the same. Restructuring in Place… but will it be enough?Recognizing the challenges of the industry, SPWR announced the first aspects of comprehensive restructuring, leaving specifics for the guidance call instead. The company currently plans to improve opex to $350m in 2017, or a ~25% reduction from our previous estimate. Additionally, SPWR is idling some manufacturing lines (clearly including E-Series specifically), shifting leases to loans/cash, and selling projects earlier than usual (to avoid tying up working capital). While this does imply lower cash use in the near term, we note a number of these proposals are opposite of SPWR's previously stated strategy geared towards greatest economic value creation. • Idling manufacturing lines: This will incur underutilization charges and comes quick on the heels of recent decisions to ramp up capacity • Shifting from leases to loans/cash. While this would require less cash upfront for financing the install, SPWR will no longer receive the tax monetization benefit, which shows up in the NCI line. In practice, this means the company will be unable to monetize the same level of solar installs • Selling projects at NTP: of the proposals, this most clearly shifts strategy towards one less focused on total value creation. Solar developers have historically made margins not by completing development on behalf of a third party, but by taking on development risk, finishing the project, then selling it as a full package. This would effectively regress SPWR back to manufacturer with an EPC arm, at least in some case. Total Partnership. Positive, but Doesn't have Strong ReadthroughsOn the call, SPWR also highlighted a four year, ~150-200MW supply agreement with Total to solarize existing facilities (presumably gas stations and other buildings) with $90M paid up front. The company's agreement includes ~150MW of E-Series panels and a 50MW of P-Series option. However, we note the company stated plans to 'right size' the E-series production given low demand elsewhere (as this is primarily a power plant product) so we see the product selection as somewhat curious. The company announced an increased R&D partnership/ cooperation with Total, including residential smart energy; this would indicate Total is taking a more active role in SPWR's development efforts vs historically. Cash goes up, EBITDA goes downUnderscoring some of the pushback we've received in the past, SPWR's adjusted EBITDA metrics include tax attributes for residential lease monetization, which leads to the strange dynamic playing out now where in order to generate more cash, SPWRs actions will reduce adjusted EBITDA. This is due to the fact that the company generates EBITDA and cash from tax monetization, yet this requires upfront investment in the system itself (which is eventually paid off, but is a near term cash draw). What's the potential Upside From The Election? While we have seen a dramatic price decline of late in panel prices, part of this is directly attributable to the defacto non-enforcement of Chinese panel tariffs, which kept prices up. More protectionist policies could actually support domestic ASPs in panel pricing, potentially providing SPWR a margin advantage again. On the other hand, SPWR's own manufacturing capacity is outside of the country, and the company is building new modco's in Mexico.
| | | PIVOTAL QUESTIONS | return ↑ | Q: Can SPWR Offset the Oversupply Environment? UBS VIEW Not enough. While there are some mitigating factors (dealer networks, three market segments etc), the drastic price decline this year has been too much for SPWR to handle. We believe the mitigation techniques the company is employing may stem the tide, but they could also be reducing longer term profitability potential. EVIDENCE While the company prices on a premium to other panels, margins are inherently dependent on commodity price concerns, and 25% ASP reduction in the last several months referenced on the call is one of the most substantial price declines ever seen in the industry. WHAT'S PRICED IN? After SPWR's initial comments around 0% power plant gross margin, we believe most investors started discounting much of the power plant earnings. FSLR results likely priced that in further, but it was only when the macro environment showed 25% ASP declines in several months that this truly showed up across the segments. |
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While SPWR had solid margins in the quarter as expected due to Henrietta, continuing pressure on power plant margins and more specifically a shift away from legacy projects is likely to keep margins well under pressure. As shown below, after adjusting for impacts from Quinto (Q4'15) and Henrietta (Q3'16), normalized power plant gross margins were really more often in the sub 20% range. Since many of these projects even outside of the two large legacy projects were still priced in a neutral environment, we believe the larger issue remains future pricing. Figure 1: Gross Margins by Segment, as Reported | 
| Source: Company Filings, UBS |
| | | UPSIDE / DOWNSIDE SPECTRUM | return ↑ | 
| SPWR is trading between $6-7/sh on 10 November 2016 |
Risk to the current share price is skewed (1.6:1) to the upside Upside (US$15): For our upside case we assume higher EBITDA stemming from reduced inefficiencies and higher demand in SPWR’s core service areas driven by higher volume. Higher EBITDA reflects improved margins and shipment profile. We apply a more optimistic 7X multiple – slightly below historical IPP peer ranges (8x) as well as reflecting full valuations vs peer equipment manufacturing peers. Base (US$7): We assume a 6x EBITDA multiple on 2018 estimates to arrive at our base target devco value off our lower estimates. This is reflective of a reasonable multiple based on historic ranges and peer sets. Downside (US$1): Our downside case assumes further compression of EBITDA from yet lower utility-scale margins. We apply a less optimistic 5X multiple – effectively to reflect the lower visibility of a resi and commercial business. We see downside risk as quite clear, emphasizing that our downgrade after substantial underperformance, seeing prospects for limited equity value should margins fail to normalize. We see mgmt's serious focus on cost reductions as illustrating the concerns of this substantial pressure and need to shore up equity value. Key Estimate ChangesWe are further reducing our estimates to account for ongoing margin pressure across the sector. This stems primarily from gross margin reductions, which would be driven both switches in how SPWR sells its products and how quickly the company can reduce costs within this environment. We believe the cost reduction strategy can play out on the opex side (we have updated our non-gaap opex from ~$531 to $350 in 2017), but see limited ability for the company to reduces costs at the necessary pace on the product side, which could put pressure on gross margins. Our previous gross margins assumed a ramp from ~12% in 2017 to 15.7% in 2020, our updated margin assumptions are below. Figure 2: UBS Gross Margin Estimates | 
| Source: Company data, UBSe |
EBITDA changes:We have reduced our EBITDA estimates for all future years as follows. Our estimates stem primarily from gross margin reductions and a ~$45M reduction in NCI (driven by how tax structures are recognized), offset by opex reduction. Figure 3: UBS EBITDA Reconciliation | 
| Source: UBSe, Company Reports |
Valuation: Reduce PT to $7 from $13We are updating our PT to $7 from $13, which is primarily reflective of our updated EBITDA estimates. There is also a slight offset from change in net debt, but on balance the $6 reduction is mostly attributable to EBITDA estimates. EBITDA Estimates: (-$5.50/sh): At a 6x multiple, our adjusted EBITDA estimates from 2018 shift our devco valuation from $18 to $13, as EBITDA shifts down from $473 in 2018 to $331. Net Debt: (-$.50/sh): Using the latest net debt outstanding, SPWR cash decreased in the quarter which increases net debt by ~$0.50/sh. Figure 4: SPWR Valuation | 
| Source: UBSe |
| | | COMPANY DESCRIPTION | return ↑ | SunPower is one of the leading global solar solutions providers for residential, commercial, and power plant customers by offering solar module technology and solar power systems. It also offers integrated Smart Energy software solutions to customers for managing and monitoring their CCOE measurement. SPWR also arranges a variety of financing solutions for customers to purchase or lease high-efficiency solar products at competitive energy rates. Industry outlook We remain bullish on the renewable energy sector, and expect solar to continue to gain market share, benefiting from trends in installation cost declines, improvements in energy efficiency, and government subsidies at federal and state levels. However, we expect a challenging supply/demand outlook in the medium term as several high-demand countries work through incentive changes, which could affect margins at the company level. | Revenues by segment (%) 
Source: Company, UBS estimates EBITDA Estimates 
Source: Company, UBS estimates |
| | | | | | | | | Forecast returns | Forecast price appreciation+10.8% | Forecast dividend yield0.0% | Forecast stock return+10.8% | Market return assumption5.9% | Forecast excess return+4.9% |
| Valuation Method and Risk Statement Risks to SunPower (SPWR) include but are not limited to: inability to raise debt, equity, working capital, and other capital sources to finance development of solar projects; rising interest rates and financing costs; lack of liquidity and failure to meet liabilities and other obligations as due; inability to transact with its jointly-owned YieldCo entities in an accretive fashion; counterparty defaults; inability to transact with third parties and realize gross margins; supply/demand imbalances; increasing cost structure and failure of solar technology to achieve 'grid parity'; increased completion for project development opportunities pressuring realized margins; technological defects and obsolescence; loss of and/or infringement on intellectual property rights; losses from cyber-attacks; lack of raw materials and necessary components needed to manufacture solar modules; supply chain delays or interruptions; sudden removal of existing government subsidies such as tax rebates or feed-in tariffs.; unfavorable international, federal, state, or local legislation/regulation; unforeseen environmental liabilities for its hazardous materials used in solar manufacturing; natural disasters; labor strikes and other unrest; adverse changes to tax subsidies for solar generation, unfavorable weather (solar resource generation); sustained declines in oil prices; shareholder and class action litigation; insider and/or concentrated shareholder selling and below-average customer demand.
Our price target remains based on an EV/EBITDA-derived SotP valuation. Required Disclosures This report has been prepared by UBS Securities LLC, an affiliate of UBS AG. UBS AG, its subsidiaries, branches and affiliates are referred to herein as UBS. For information on the ways in which UBS manages conflicts and maintains independence of its research product; historical performance information; and certain additional disclosures concerning UBS research recommendations, please visit www.ubs.com/disclosures. The figures contained in performance charts refer to the past; past performance is not a reliable indicator of future results. Additional information will be made available upon request. UBS Securities Co. Limited is licensed to conduct securities investment consultancy businesses by the China Securities Regulatory Commission. UBS acts or may act as principal in the debt securities (or in related derivatives) that may be the subject of this report. This recommendation was finalized on: 11 November 2016 07:46 AM GMT. Analyst Certification: Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner, including with respect to UBS, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. UBS Investment Research: Global Equity Rating Definitions 12-Month Rating | Definition | Coverage | IB Services | Buy | FSR is > 6% above the MRA. | 45% | 28% | Neutral | FSR is between -6% and 6% of the MRA. | 39% | 25% | Sell | FSR is > 6% below the MRA. | 15% | 17% | Short-Term Rating | Definition | Coverage | IB Services | Buy | Stock price expected to rise within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% | Sell | Stock price expected to fall within three months from the time the rating was assigned because of a specific catalyst or event. | <1% | <1% |
Source: UBS. Rating allocations are as of 30 September 2016.
1:Percentage of companies under coverage globally within the 12-month rating category.
2:Percentage of companies within the 12-month rating category for which investment banking (IB) services were provided within the past 12 months.
3:Percentage of companies under coverage globally within the Short-Term rating category.
4:Percentage of companies within the Short-Term rating category for which investment banking (IB) services were provided within the past 12 months. KEY DEFINITIONS: Forecast Stock Return (FSR) is defined as expected percentage price appreciation plus gross dividend yield over the next 12 months. Market Return Assumption (MRA) is defined as the one-year local market interest rate plus 5% (a proxy for, and not a forecast of, the equity risk premium). Under Review (UR) Stocks may be flagged as UR by the analyst, indicating that the stock's price target and/or rating are subject to possible change in the near term, usually in response to an event that may affect the investment case or valuation. Short-Term Ratings reflect the expected near-term (up to three months) performance of the stock and do not reflect any change in the fundamental view or investment case. Equity Price Targets have an investment horizon of 12 months. EXCEPTIONS AND SPECIAL CASES: UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Sell: Negative on factors such as structure, management, performance record, discount. Core Banding Exceptions (CBE): Exceptions to the standard +/-6% bands may be granted by the Investment Review Committee (IRC). Factors considered by the IRC include the stock's volatility and the credit spread of the respective company's debt. As a result, stocks deemed to be very high or low risk may be subject to higher or lower bands as they relate to the rating. When such exceptions apply, they will be identified in the Company Disclosures table in the relevant research piece. Research analysts contributing to this report who are employed by any non-US affiliate of UBS Securities LLC are not registered/qualified as research analysts with FINRA. Such analysts may not be associated persons of UBS Securities LLC and therefore are not subject to the FINRA restrictions on communications with a subject company, public appearances, and trading securities held by a research analyst account. The name of each affiliate and analyst employed by that affiliate contributing to this report, if any, follows. UBS Securities LLC: Julien Dumoulin-Smith; Jerimiah Booream, CFA. Company Disclosures Company Name | Reuters | 12-month rating | Short-term rating | Price | Price date | SunPower Corp | SPWR.O | Buy | N/A | US$6.32 | 10 Nov 2016 |
Source: UBS. All prices as of local market close.
Ratings in this table are the most current published ratings prior to this report. They may be more recent than the stock pricing date 16.UBS Securities LLC makes a market in the securities and/or ADRs of this company. Unless otherwise indicated, please refer to the Valuation and Risk sections within the body of this report. For a complete set of disclosure statements associated with the companies discussed in this report, including information on valuation and risk, please contact UBS Securities LLC, 1285 Avenue of Americas, New York, NY 10019, USA, Attention: Investment Research. SunPower Corp (US$) 
Source: UBS; as of 10 Nov 2016 |
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