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Aug 11, 2021
[7 min Read]
Array has had a rough time so far as a public company, with shares opening at over $36 upon IPO, only to recently settle in the $15 range.
Steel costs rocketed higher this winter and spring leading to an unexpected guidance pull from the company. In my opinion, this is a temporary issue.
Commodity mismanagement is certainly a ding to management's credibility, however the recently announced Nucor supply deal does provide a backstop.
Array boasts a high quality and in demand product that is essential to the solar industry, making this potentially an opportune time to build a position.
Array Technologies $ARRY burst onto my radar screen upon the company's IPO in October 2020. I was quite curious about the company and its products due to the alternative energy boom currently engulfing the energy industry worldwide.
What I found in my initial research during the company's IPO process was a wonderful, innovative company, with one of the best solar tracking products in the marketplace, along with a stock that upon IPO, was significantly overvalued.
In this article, I would like to explore the recent crash in the price of Array Technologies and present my thesis for why this may be a great time to build a position in the company.
The first quarter of 2021 for Array was certainly one to forget, while demand continued to rip along at a record pace, costs for steel and shipping the company's products more than doubled.
With rolled steel accounting for greater than half of the cost of goods sold at the company, along with no hedging program of note in place, the company pulled guidance pending a review of the impact, sending the stock tanking to the range that we find currently.
Data by YCharts
To those unfamiliar with Array Technologies, the main product that they produce are solar trackers. The basic concept behind a solar tracker is to keep the solar panels at a solar power generation plant pointed at the sun at the proper angle needed for maximum energy capture at all times.
Solar trackers are certainly not a new thing in the industry, however perfecting the system is surprisingly complex. The tracking system acts like a mobile weather station, adjusting panels minutely based on cloud cover, humidity, temperature and acting as a damage control system for the panels in case of high winds or hailstorms.
In addition, tracking systems have now added a machine learning layer by gathering system generation data and optimizing panel position based on previous site-specific experience.
Solar tracking systems have certainly come a long way from the relatively simple, algorithmic based systems of a decade ago and Array claims to have the best in the business.
It would certainly appear that they can back up the claim per SEC filings:
TÜV Rheinland PTL, an internationally-recognized testing, inspection and certification company that has been providing independent evaluations of equipment used in solar energy projects for more than three decades, found that projects using Array's tracker system would achieve a 6.7% lower LCOE, 4.5% higher net present value, and 31% lower operations and maintenance cost than projects that used competing single row control architectures.
The solar tracking market is dominated by Array Technologies, Nextracker, PV Hardware and Arctech Solar with Nextracker and Array holding the number 1 and 2 positions, respectively. This is a rapidly growing market both domestically and internationally due to the relatively recent mainstream adoption of mechanical tracking systems over fixed systems.
Solar Tracker Market Opportunities and Demand (2020-2026) | See Key
See Source: Fortune Business Insights
International expansion is firmly on the company's mind going forward as the benefits of Array's tracking system are not geographically limited, in fact, the company's lower installation costs, agnostic panel compatibility and generous terrain accommodations make the system quite attractive in foreign markets around the globe.
The company has noted international expansion as a key growth driver going forward and recently signed large deals in Spain and Australia with nearly 22% of deals closed in 2020 in foreign jurisdictions.
The company clearly has quite a lot going for it. In my opinion, the company has the best offering available in the solar tracking market, in addition, the solar industry is clearly showing no signs of slowing down any time soon.
The Achilles' heel to the story so far in 2021 has been the unprecedented rise in commodity costs hitting the company squarely in the largest input factors available for its product, literally, the nuts and bolts.
As I showed in a graph earlier, rolled steel prices have now hit the highest price in history and did so in a period of only a few months' time. Rolled steel has always been a volatile product but a 200%+ rise in a few months is unheard of, even for steel prices.
This has clearly caught Array squarely off guard as projects that were quoted and signed in August, September or even October 2020 at a 20-25% margin would now be produced and sold at a significant loss.
As a result of the rapid rise in steel prices and scarce inventory, the company has entered into a long-term supply agreement with Nucor (NUE) to secure product availability. In addition, the company expects to renegotiate contracts currently under production to pass along the increased costs associated with the meteoric rise.
The miniscule silver lining to the story is that Array estimates that all solar tracking providers are equally or even more so affected by this development. As a larger player in the industry, the company believes that they are positioned better than other players in the ability to secure contracts such as the Nucor supply agreement during this period, making renegotiations easier as they can at least guarantee providing a product.
Management clearly deserves a hefty helping of blame for the current situation as a decent hedging program and a supply agreement such as the recent Nucor deal could have benefitted the company immensely. Hindsight thinking serves no purpose unless you learn from your mistakes and it is clear that management is actively navigating the current environment in a proactive manner.
In my opinion, the current steel price is clearly not sustainable. The rise in steel prices can be attributed to a perfect storm of low inventories due to COVID shutdowns, unemployment benefits keeping workers home longer than they likely needed to and the euphoria created by the infrastructure bill proposed by the Biden administration.
Each of these factors is temporary in nature and with hot rolled prices reaching $1800 a ton, steel mills will be firing on all cylinders soon enough.
Steel production and utilization rates as of March 2021 were already back to 87.5% of pre COVID levels and with the type of gangbuster margins to be had by steel producers currently, I see the below graph going up and to the right much further in the months to come. Steel mills in driver seat a year after Covid hit US
Source: American Iron and Steel Institute
It may take 6 months, it may take 2 years, but steel prices will certainly not remain at these levels permanently. In addition, even if steel prices do stay elevated, the problem for Array is mostly due to contracts already signed and in production. For future contracts, the company has the ability to quote spot prices in negotiations if needed to maintain healthy margins.
A tracking system currently makes up only around 12% of the capital expenditure of a utility scale solar project, giving a potential rise in costs a margin of safety in regard to the viability of any said project.
See Source: Bloomberg graph (sorry I have not included any of the graphs but they are verifiable)
Array Technologies appears to have a wonderful product, in a durable, fast-growing sector of the economy. It also appears to be the victim of a temporary bottleneck that is likely to be resolved in a somewhat reasonable time frame.
The stock has tanked by nearly 70% from its $51.05 high shortly after the IPO. I personally found the stock to be significantly overvalued upon IPO and was originally interested in purchasing at a $25 price point.
Thanks to the steel price bonanza, I was able to purchase a sizable position for a cost basis around $15. This may take some time to play out given the commodity market is notoriously hard to predict; however, fundamentally the shift to solar power is extremely likely to continue onwards and upwards in the future and in my opinion, Array currently has the best product available for utility scale projects.
Earnings estimates for Array currently are nothing more than guesses due to the plethora of moving parts such as renegotiations, steel prices, cancellations etc., so I am going to refer to prior estimates for a guidepost of steady state earnings once the situation stabilizes.
Prior to the steel price explosion, Array was estimated to earn $1.04 in 2022. In addition, the company was estimated to grow EPS at close to a 20% rate for the next 5 years.
I view Array basically the same as I did at the IPO, only with a longer fuse to account for the time needed for stabilization. I would currently place fair value of the company at $21, assigning a 20 PE to shares based on normalized potential earnings power, making this investment roughly 33% undervalued in my opinion.
In the current market environment, a 33% discount looks pretty good to me and I plan to continue to nibble at shares on weakness.
It's funny that the Roth analyst that issued the $25 price target yesterday mentioned that if they leverage their steel pricing they could see a significant rise in share price. Now they have a deal with Nucor.