Suntech Selloff Sweetens Entry Point

Given the company's excellent growth rate, the stock is trading at compelling valuations.
Author:
Publish date:

This was originally sent to subscribers of TheStreet.com Breakout Stocks on Feb. 14 at 10:58 a.m. EST. For more information on this newsletter, click here.

Suntech Power

(STP)

reported fourth-quarter earnings results after the close last night, and shares are off a quick 14.3% to $32.92. We have had Suntech on our radar screen as a possible addition to our model portfolio into weakness, and want to alert subscribers that we will consider a long position should this pullback continue to $30 a share.

Suntech is a leading solar cell and modules maker in China. The company went public in December at $15 a share, and is up 130% since the offering for a few reasons:

First, solar power is gaining greater global acceptance as an affordable alternative to oil and gas, which remain well above historical average prices.

Second, tax credits and incentives from state and federal governments in the U.S. and abroad make solar installations affordable and sensible.

Finally, global warming and continued declines in oil and gas discoveries and production have created an urgency to find alternatives to traditional energy sources.

However, Suntech shares are being punished by short-term investors who were looking for a large upside surprise in the company's fourth-quarter earnings report. While the upside may not have lived up to some investors' expectations, the earnings report showed steady and solid revenue growth, and management's earnings guidance for the first quarter increased our confidence that Suntech will be able to deliver strong sequential revenue gains.

For the quarter, Suntech earned 10 cents a share on revenue of $89 million. The Street was looking for EPS of 6 cents and revenue of $75 million, so results were clearly ahead of expectations. Even so, it appears that investors are using the company's 26.5% gross margin, which was some 100 basis points below most analyst models, as a reason to sell the stock.

Also, the company's first-quarter guidance for revenue of $75 million to $80 million, while slightly ahead of the Street's $75 million forecast, appears to be insufficient to satiate the short-term momentum investors in the stock.

We believe investors are missing the forest for the trees, and that a pullback to $30 a share will create a solid entry point for investors with three- to 12-month time horizons. Competitor

SunPower's

(SPWR) - Get Report

fourth-quarter gross margin of 19.8% was applauded by investors, as it was slightly ahead of expectations. Comparatively, Suntech's 26.5% margin shows a greater degree of potential profitability and cash flow, so we are not overly concerned that the company failed to hit Wall Street's target.

Also, Suntech's management spoke optimistically about expanding the company's capacity to meet surging demand. In the fourth quarter, Suntech sold 26.3 megawatts of solar cells, marking about a 50% expansion from the prior quarter.

The company issued guidance for only 23 to 24 megawatts of solar production in the first quarter, though, which may prove conservative given its ability to produce in greater volume -- as evidenced in the fourth quarter -- and strong end-market demand that will likely force 100% capacity utilization at Suntech.

We believe Suntech's valuation is compelling. At the current quote, Suntech is changing hands at about 42 times 2006 analyst EPS forecasts and just 20 times 2007 earnings estimates. Even so, earnings are forecast to grow some 200% in 2006 to 70 cents a share, and another 150% in 2007 to nearly $1.80 a share.

Given the company's superior and accelerating growth rate, we believe the stock trades at a compelling valuation. Also, the company is forecast by analysts to have $485 million in sales in 2006, which would mark about 115% total growth from 2005 sales of $226 million. We believe capacity constraints in the solar industry will support above-average EPS growth for the foreseeable future.

We believe this pullback may entice Credit Suisse First Boston and Morgan Stanley, which each rate the stock a hold, to consider upgrading shares to buy. The average target price of these analysts is $39 a share, which represents compelling 15% upside from the current price and warrants a more bullish stance.

Even so, we believe the stock has a great deal of "fast money" in it from daytraders and short-term momentum-oriented investors because of its strong performance since coming public. As such, we believe this morning's selloff may continue for a day or two and provide an even better entry point. As such we are going to wait for a pullback closer to $30 a share before taking action for the model portfolio.

The TSC Breakout Stocks Team is Michael Comeau and William Gabrielski, research associates at TheStreet.com. In keeping with TSC's editorial policy, they don't own or short individual stocks. They also don't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. For more information about Breakout Stocks, please

click here.