Tuesday, June 07, 2011

Sizzlin' in the Sun

Temperatures are soaring across the U.S., but things are really sizzlin’ at one of the countries most important players in the solar power industry.  Yet it is a record $460.4 million order for advanced sapphire crystallization furnaces from an unnamed Chinese customer in the LED industry has turned up the heat at GT Solar International, Inc. (SOLR:  Nasdaq). 

Based in New Hampshire, GT Solar produces polysilcon production technology, and sapphire and silicon crystalline growth systems and materials for the solar, LED and other specialty markets.  Industry analysts view LED or Light Emitting Diodes as among the highest growth sectors in the lighting industry as consumers end their use of energy-hungry incandescent bulbs.  The record order  -  at least for GT Solar  -  is touted by management as proof the company’s leadership in the LED market.  The very brightest LEDs are manufactured on sapphire wafers and GT Solar claims its ASF 100 sapphire furnace is top notch.

GT Solar is not alone in the field.  It faces competition from two private companies with sapphire furnaces, Thermal Technology, LLC based in Santa Rose, CA and Advanced Renewable Energy Company, LLC.  Thermal Technology introduced its 90 kg Kyropoulos sapphire crystal grower in December 2010 and says it is suitable for growing LED substrates.  Advanced Renewable Energy Co. or ARC Energy is developing highly automated turn-key sapphire crystal growth and processing equipment.  The Product Page of its corporate web site says the company is in “stealth” mode.  Whatever that means, it appears GT Solar is a few steps ahead of at least two other sapphire furnaces suppliers at least to the extent that a customer has trusted GT Solar with a very large, mission critical order.

The sapphire furnace market is not the only playground for GT Solar.  The company is also a major supplier of sapphire substrate materials.  GT Solar is estimated to supply about one-third of the sapphire cores used in LED light production.  Rubicon Technology, Inc.  (RBCN:  Nasdaq) is among GT Solar’s principal competitors in selling sapphire substrates.  Following GT Solar’s fourth quarter 2011 earnings conference call at the end of May 2011, there was considerable speculation among bloggers and chat room visitors that GT Solar might be targeting a competitor in the space for another acquisition, with Rubicon getting named most frequently.

Competitive vigor is not the only reason to consider GT Solar shares.  The stock is trading at 6.8 times projected earnings.  According to Thomson-Reuters the consensus among twelve analysts is $1.67 in earnings per share for the fiscal year ending March 2012.  One of the sell-side firms following GT Solar recently increased its price target to $24.00, implying a forward PE of 14.5.  The median price target is $16.00 for a 9.6 forward multiple. 

Did these analysts forget how to use their calculators?  How could they miss the 19.4% net profit margin and the 15% projected compound annual growth rate?  Granted GT Solar has some debt  -  $120.3 million at the end of March 2011.  However, the cash conversion rate is 28% and cash has built up to $362.8 million. 

Given strong fundamentals, the sophisticated, highly proprietary technologies behind the Company’s products, the scale and pace of growth in its target markets, and the Company’s clear leadership position, it seems like the stock should trade well above 10.0 times earnings, maybe even as high as the S&P 500 average price/earnings ratio of 22.8. 

We note RBCN is trading at 8.9 times forward earnings, which puts GT Solar at a bit of a disadvantage in making a case for an acquisition based only on relative valuation.  Shareholders of GT Solar would have to want that dominant market position in the sapphire substrate materials market to make that deal palatable.

If GT Solar is as undervalued as I believe, it could be a takeover target itself.  With $899 million in revenue in FY11, the Company appears poised to reach the magic $1.0 billion market in the next few months.  It is highly profitable and management appears to have a laser focus on capturing market share.  A chip maker like Applied Materials (AMAT:  Nasdaq) or a semiconductor equipment producer like KLA-Tencor Corp. (KLAC:  Nasdaq) might find GT Solar a juicy deal to boost top-line and profits.  KLA-Tencor might seem a stretch, but it is already selling its inspection and metrology equipment to the LED light producers.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.  SOLR is included in Crystal Equity Research’s The Atomics Index in the Solar Group.

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