It has been a little over six weeks since SunPower’s (SPWR) spin-off of its solar module manufacturing segment Maxeon Solar Technologies (MAXN). Since the split, SunPower has rallied over 50% while Maxeon is down 10% from its post spin-off closing price of $19. While the separation initially raised questions, both management teams have done a good job detailing the advantages for each company as a separate operating entity. I have already covered SunPower’s post split prospects, so this article will focus solely on Maxeon as a standalone company. As a pure play premium solar module manufacturer with American origins, Maxeon Solar is highly leveraged to demand surges and thus could be one of the biggest beneficiaries of a Biden Presidency.
Spin-off Positives And Negatives
As I wrote in a recent SunPower article, one of the key reasons for the separation was to clean up the earnings statement and balance sheet. With inter-company eliminations removed, both companies should report more transparent earnings. In addition, incremental revenues and earnings would be unlocked by the two companies with the majority belonging to Maxeon. As a single company, Maxeon’s solar module sales to SunPower were eliminated to avoid double counting.
A key selling point for Maxeon’s spin-off was a fresh and clean balance sheet. Most of SunPower’s legacy debt, including $800 million in convertible bonds, would remain with SunPower. SunPower’s China joint venture parent Zhonghuan Semiconductor [TZS] would also make a $298 million investment for a 28.9% stake in the new Maxeon. With a clean starting balance sheet, Maxeon was able to issue $200 million in five-year convertible debt to bring its working capital over $500 million.
Working capital is critical for Maxeon because it will allow the company to upgrade its legacy Maxeon 2 production to the current and more profitable Maxeon 5/6 products. The gradual and limited Maxeon 5 retrofitting to just 300 MW in 2019 helped Sunpower’s adjusted gross margin expand from 7.5% in fiscal 2018 to 14% in 2019. In its 2020 Capital Markets Day presentation, management stated Maxeon 5/6 gross margin to be in the high 20s percentile. Fully converting its unprofitable legacy manufacturing lines would thus be critical to its future profitability and only possible with an additional $385 million in capital expenditures currently planned through 2022. Under the old single company structure with over $1 billion in debt outstanding last year, this manufacturing upgrade would have been difficult if not impossible.
Legacy Liability Overhang
On the negative side, Maxeon would have to take SunPower’s legacy polysilicon supply agreements. Signed over a decade ago, it committed the company to purchase fixed volumes of polysilicon at agreed upon pricing which I estimate was around $30/kg in 2019 based on contractual draw down and above market price losses. With current spot market polysilicon pricing around $11/kg plus or minus a couple dollars depending on grade, Maxeon will continue to incur losses until the contract volume has been fully consumed.
According to its 20-F filing, the contract length was extended through the end of 2022 instead of by the end of 2020. This would spread committed purchases out further and thus free critical cash flow required for capital expenditures. Based on polysilicon pricing during the summer, Maxeon estimated an additional $258 million in above market polysilicon losses would be incurred through the end of the contract. The extension would thus spread the losses to approximately $25 million per quarter until the end of 2022.
Maxeon did note that each 10% move in polysilicon pricing would impact its projected above market loss by $9 million. If the expected losses were based on mono-grade polysilicon pricing in China, total contracted losses could be lower. Since early July, polysilicon spot pricing surged by over 50% albeit from very depressed levels due to COVID-19 related shutdowns. Under this assumption, the projected losses over the remaining contract length could be reduced by over $40 million. Maxeon should be procuring most of its polysilicon requirements from China since its cell manufacturing plants are in East Asia. In past quarters, portions of its contracted polysilicon produced in the US were simply resold at losses which made more logistical sense.
On a GAAP basis, Maxeon’s earnings through the end of 2022 will be negatively impacted by $20-25 million per quarter due to this legacy polysilicon contract. Prior to its spin-off, SunPower investors accepted non-GAAP earnings which excluded above market polysilicon losses. If this trend continues with Maxeon, these legacy polysilicon losses should not impact the stock’s valuation.
At the end of Q2 2020, Maxeon had $109 million in advances to suppliers linked to its polysilicon contracts. Thus, the overall negative cash impact should only be around $11 million per quarter at current polysilicon spot market pricing. While still a big negative, this legacy liability would still be manageable and the price the company had to pay in order to free up cash for its manufacturing upgrades.
Based on past industry cycles, solar equipment manufacturers have been the most levered to up cycles. This has been the case because during all other periods, manufacturers often did not operate at peak efficiency. Overcapacity has been a constant issue and thus many manufacturers often operated at undercapacity or at lower margins. In contrast, downstream installers typically had a more constant business stream due to the long lead times required to plan and build out solar projects.
Although Maxeon does sell its modules throughout the world, it is important to keep in mind that its short- to intermediate-term earnings leverage will likely be linked to the US. With Presidential candidate Biden holding large leads in current polling, solar deployment in the US could see a significant boom under a Democratic administration.
In 2019, the US installed approximately 13.3 GW of solar. Under the right policies, it would not be a stretch to see US annual solar installations double sometime during a first presidential term. Policy changes have caused significant increases in annual solar installation in many European countries during the past decade. In another example, the announcement of feed-in-tariff support for solar in China resulted in a huge boom in 2013 and beyond.
Maxeon currently is somewhat capacity constrained. Based on its recently updated 20-F filing, it has 1450 MW of its proprietary IBC capacity that should experience a competitive advantage in the US market. The first advantage is due to a differentiating technology that allows for higher operating efficiencies. The second advantage is the Section 201 Solar Tariff exemption it was granted. Lastly because its modules are manufactured outside of China, Section 301 tariffs also would not apply. These combined factors narrow the pricing premium the SunPower brand commands over commoditized p-type solar modules. If US solar policy changes results in a demand surge, Maxeon would likely route all of its IBC supply to the US market where it would enjoy the highest margins.
Maxeon also has at least 1400 MW of P Series produced by its Chinese joint venture partner. However, this mainstream p-type product line would not enjoy tariff exemptions and thus would have to compete with larger established top tier Chinese manufacturers. Since many leading Chinese manufacturers have factories outside of China and would not be subject to Section 301 tariffs, Maxeon’s P Series would be at a severe competitive disadvantage in the US market and thus its production would likely be sold in other regions of the world.
2021 Gross Profit Potential
Based on the SEIA’s current outlook for the US solar market in 2021 which calls for a modest 10% annual growth regardless of the election outcome, Maxeon’s 2021 starting IBC module capacity of 1,450 MW will likely be sold out. Just prior to the COVID-19 outbreak, SunPower had already forecast 1,400 MW IBC shipments in 2020. With shipments pushed back due to mandatory shutdowns, some of the 2020 expected shipment volume will likely be recognized in 2021. Maxeon’s larger peers have all cited demand deferment rather than demand destruction due to COVID-19 and have kept or raised shipment forecasts.
Maxeon plans to expand its Maxeon 5 capacity to 1 GW by the end of 2021. Assuming linear addition of new lines throughout 2021, actual Maxeon 5 production would likely be increased to the midpoint of its starting and ending manufacturing capacity. The estimate below assumes a midpoint of 750 MW for Maxeon 5 shipments. Although Maxeon’s China JV plans to expand P Series from 2 GW to 8 GW by the end of next year, P Series shipments have been left constant for the sake of conservatism. Since P Series gross margin is shared by the JV partner, its contributing gross profit would not be a major factor even if annual shipments potentially doubled next year. My per watt gross margin assumptions were explained in greater detail in a previous article.
Potential Shipments And Gross Margin Profile For FY2021
|Capacity in MW||Gross Margin per watt||Gross Profit||ASP per watt||Revenues|
(Revenue and gross profit estimates in millions of USD. Maxeon 5 shipments could include the slightly updated Maxeon 6 modules which uses slightly larger silicon wafers.)
The blended gross margin for the estimate above is 14%, slightly below Maxeon’s over 15% normalized target. Maxeon 5 gross margin of 28.5% is in line with management statements of ‘high 20s’. To be conservative, I used zero gross margin for its legacy Maxeon 2 and just 8.3% gross margin for Maxeon 3. Most likely the gross margin for older Maxeon lines will be slightly higher but not enough to significantly change the blended total. P Series gross margin is based on profit profiles of top tier Chinese manufacturers for similar products, but reduced to account for JV profit sharing. As clearly shown, the bulk of Maxeon’s potential gross profit will be linked to its conversion of older lines to Maxeon 5.
Assuming this gross profit estimate is within the margin of error, we can make a simplified EPS estimate. In the first half of 2020, Maxeon’s portion of operating expenses were $60.7 million which is down from last year’s $133 million annual figure. Management has been indicating continued cost controls which targeted a 10% reduction in operating expenses, so annualizing first half expenses would result in the targeted 10% year-over-year reduction.
2021 Earnings Estimates
- Revenues: $1565 million
- Gross Profit: $220 million
- Gross Margin: 14.1%
- Operating Expenses: $120 million
- Operating Profit: $100 million
- Interest Expense: $15 million
- Tax (25%): $21 million
- Net Income: $64 million
- Diluted Share Count: 41 million
- Adjusted Non-GAAP EPS: $1.56
The estimates above are adjusted to exclude above market polysilicon losses which could range anywhere from $80 to $100 million per year for 2021-2022. Thus, on a GAAP level using metrics listed above, the company’s 2021 GAAP EPS could range from break-even to a loss of -$0.37. Adjusted EBITDA assuming $60 million annual depreciation would thus be $160 million or a tick above 10% adjusted EBITDA margin. Management’s targeted adjusted EBITDA margin is over 12%.
Other assumptions used in the estimate above are based on:
- Interest expenses assume the 6.5% rate of its convertible bonds applied to the company’s entire debt.
- Maxeon is incorporated in Singapore which has a corporate tax rate of 17%. The 25% tax rate assumption is based on the average rates of large Chinese module manufacturing peers that also sell to the same markets. Corporate tax rates for high technology companies in China average between 15-20%.
- Diluted share count based on the company’s post spin-off share count plus full dilution from its recent $200 million convertible bond which converts at $18.20.
Potential Normalized Earnings For 2022
While actual adjusted earnings for 2021 could vary from the estimates above mainly due to the schedule of its Maxeon 5 expansion, normalized earnings after 2021 should continue to rise. First, the main profit generator Maxeon 5 capacity would start 2022 at 1,000 GW, or 33% higher than the 2021 figure used above. If Maxeon is successful in marketing its P Series in DG markets around the world, P Series shipments could eventually exceed 5 GW.
Under peak conditions without assuming new revenue sources, normalized gross profit in 2022 could be over 50% higher than the 2021 estimate above, or above $350 million. Since IBC shipments would simply be shifted from lower margin to higher margin products without a meaningful increase in actual shipments, operating expenses on an absolute level should stay relatively flat. In addition, JV profit sharing on higher P Series shipments would also unlikely result in higher operating expenses for Maxeon. Maxeon is in essence receiving a cut from its Chinese JV for its technology and branding usage. These two factors will likely be key in pushing gross margin and adjusted EBITDA to the company’s long-term targeted range.
While Maxeon has not mentioned long-term Maxeon 5 capacity targets in recent presentations, a 1,900 MW figure was mentioned in the company’s original spin-off presentation. Last year, the company achieved a two to one capacity increase from converting its legacy Maxeon 2 lines to Maxeon 5. Thus, a 1,900 MW Maxeon 5 target would require a full conversion of its 900 MW Maxeon 2 fab. If this target is reached, Maxeon’s gross profit potential would be double the $220 million used in the estimate above. Annual EPS could potentially expand beyond $4.00 just by fully converting its Malaysian cell plant to Maxeon 5.
Other factors that could push long-term adjusted EBITDA above my current estimate and within the company’s normalized target are new products. While the lost monetization of AC modules in the North American market to SunPower is slightly disappointing, the announcement Maxeon would partner with Enphase Energy (ENPH) to sell AC modules outside North America should bring in additional revenue and gross profits. In addition, Maxeon plans to add storage options in the near future.
SunPower posted large losses for years due to an inefficient manufacturing supply chain, high manufacturing cost products, and a massive long-term supply agreement blunder which Maxeon will continue to pay for in the next two years. While the current supply chain is still not as efficient as large Chinese peers, the introduction of its next generation Maxeon 5 and 6 product line has finally given the company a cost competitive product.
Of course, since the outbreak of COVID-19, business activity has been turned upside down for many industries. SunPower’s Maxeon unit was hit on both the supply and demand side during the first half of 2020. Low utilization rates have made it impossible to evaluate the company’s operations so far this year. Therefore, investors have to take a longer term approach and evaluate Maxeon’s post spin-off earnings potential for next year using metrics already proven possible during pre-pandemic operations. As my rough estimate above show, Maxeon’s earnings power could be quite high under normalized conditions which could occur next year. A Biden victory would not only ensure Maxeon sells out its limited capacity, but potentially at incrementally higher margins due to the limited global capacity that would be competitive in a protected US market.
Current Wall Street estimates are unbelievably low for Maxeon. Excluding a potentially horrible 2020, estimates for 2021 and 2022 are impossibly low. For example, the current revenue estimate for 2021 is just $960 million. This would be a full 20% lower than fiscal 2019 revenues. While average selling prices [ASP] could be slightly lower, the conversion of legacy Maxeon 2 to next generation Maxeon 5/6 should be an incremental boost to revenues due to the higher ASPs these premium products command. For revenues to drop this much implies its products not being accepted by the market which is contrary to the company’s reported results prior to the outbreak of COVID-19. SunPower enjoyed over 83% shipment growth in fiscal 2019 over 2018.
Granted there are currently only two analysts covering Maxeon. In fact, one of the covering analysts, Brian Lee recently downgraded Maxeon to a sell with a $15 price target. As long time followers of my solar articles already know, I have had a very hard time reconciling the numbers provided by solar industry analysts in general. For example, I have been covering JinkoSolar (JKS) for over a decade and found it mind boggling the same analyst who just downgraded Maxeon also downgraded JKS to a sell with an $8 price target when it was trading at $10 last year. During the same fiscal year of this downgrade, JinkoSolar posted $2.79 in GAAP EPS and $3.29 in non-GAAP EPS which excludes share-based compensation. Thus, with an $8 price target, the analyst only valued Jinko at 3x current year’s GAAP earnings. As typically the case, the market ultimately rewarded investors as Jinko continually grew its earnings.
Perhaps due to a lack of broad analyst coverage and in part due to the negativity of the few analysts currently covering Maxeon that the stock has lagged its US listed solar peers. This could lead to a longer-term buying opportunity for investors if Maxeon delivers earnings near my estimates. With the odds of a greener administration currently higher than not, Maxeon’s intermediate term earnings power could be further boosted as the company enters into the final stages of a multi-year restructuring transition. Those who missed the 500-1,000% rallies in leading solar stocks during the past couple years could be getting another chance with Maxeon Solar.
Disclosure: I am/we are long MAXN, SPWR, JKS, ENPH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.