Merrill Lynch Identifies Solar Stock Winners

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Over the next several days and into next week, a number of solar energy companies will be reporting quarterly results. While the growth of solar energy is impressive as costs fall, the industry has yet to solve once and for all how to finance further growth, particularly in the residential rooftop business.

Analysts at Merrill Lynch characterize the state of the market for solar as lingering pessimism, along with a bright outlook. The analysts forecast a 19% rise in global demand for solar and a similarly sized rise in U.S. demand for residential solar installations for 2016. They frame the drag on the sector this way:

[N]egative sentiment has continued to surround the overall solar market as the ability to finance solar and the sustainability of current business models have come into question. Some debt-heavy companies may need additional financial assistance in the short-term in order to provide their long-term value prospects.

Merrill Lynch’s top pick in the sector is SunPower Corp. (NASDAQ: SPWR), now trading at nine times the firm’s fiscal year 2017 estimated earnings. The analysts wrote:

We base our $31 [price objective] on the average of a 9x multiple on 2017E EBITDA (appropriate in our view given that 9x is the implied multiple on our 2017 estimates for peer company First Solar, and is in-line with yieldco valuation differentials), and an analysis of SunPower’s project pipeline comprised of utility-scale, commercial, and residential solar assets. We value the project pipeline at roughly $5.2 billion, or $37 per share, based on an average 9.8% yield on forecast distributed cash flow from approximately 5,500MWac of our 11,200MWac pipeline estimate. 9x on 2017 EBITDA implies $25. Our PO of $31 is the average of both.

SunPower closed at $14.58 on Friday and traded up about 0.3% Monday morning, at $14.67 in a 52-week range of $13.29 to $31.10. The consensus 12-month price target on the stock is $30.04.

Merrill Lynch is also bullish on Sunrun Inc. (NASDAQ: RUN):

We value SunRun at $9 per share. Our valuation is based on an analysis of EBITDA and levered free cash flow generation from the company’s fleet of long-term contracted solar energy assets. We employ a peer group of US-focused YieldCos in our comparable valuation approach. At 10x our estimate of CY17 EBITDA generation from operating assets, we value RUN shares at $10 on a rounded basis. At an 10% yield on our CY17 levered free cash flow estimate less net recourse debt we value RUN shares at $8 on a rounded basis. The average of the two approaches represents our $9 [price objective].

The stock closed at $5.18 on Friday and traded down about 2.5% to $5.05 Monday, in a 52-week range of $0.01 to $14.95. The 12-month price target on the stock is $12.39.

First Solar Inc. (NASDAQ: FSLR) is rated Neutral at Merrill Lynch. The firm’s analysis:

We value First Solar primarily on an analysis of its pipeline, consisting of contracted assets that have been sold to third parties but for which revenue has not yet been recognized, contracted assets that are unsold, and mid-late and early stage development opportunities. Our estimated pipeline value and price objective of $68/share is based on a target 8% yield on the distributable cash flow after requisite financing payments we estimate the pipeline can generate for US assets, and a 12.5% yield for international assets which represents a reasonable discount for international assets based on yieldco valuation differentials. Our target yield is based on observed transaction values in the marketplace. The implied multiple on CY17 EPS estimate is 20x (16x CY17 EPS after adding back roughly $15 in net cash per share).

Shares of First Solar closed Friday at $46.68 and traded up about 1% Monday, at $47.17 in a 52-week range of $40.25 to $72.49. The consensus 12-month price target is $67.13.

The analysts have bearish views on residential installer Vivint Solar Inc. (NYSE: VSLR) and inverter maker Enphase Energy Inc. (NASDAQ: ENPH). Both are rated Underperform, Vivint due to its being the most sensitive to financing constraints and Enphase due to margin and growth challenges.

Vivint shares closed at $3.02 on Friday and traded down about 1.7% Monday, at $2.97 in a 52-week range of $2.16 to $15.51. The 12-month price target on the stock is $4.95.

Shares of Enphase traded at $1.80 Monday morning, flat with Friday’s closing price. The stock’s 52-week range is $1.63 to $7.10 and the consensus 12-month price target is $2.58.

Merrill Lynch noted that the first half of 2016 has been tough on solar stocks. Share prices on its Buy-rated stocks are down 53% and down 58% on those it rates Underperform. The good news for investors, say the analysts, is that companies like SunPower and First Solar are becoming more attractive at these valuations. Significant short interest or lengthy days to cover signal negative sentiment on both Vivint and Enphase.

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