Description
In December of 2020, Mason pitched Array Technologies as a short at $45, which proved to be an excellent call. The stock fell below $13 by Aug of 2021, and traded at $17 in mid-August when Mason recommended exiting the position.
Today, most of the issues that led to Mason's short pitch have been resolved or improved, and at $14 a share, the stock has at least 50-60% upside to fair value.
Background:
Array Technologies is the second largest global solar tracking company, at around 24% share, behind Nextracker at roughly 30%. The next largest company has around 9% share.
Solar trackers have many benefits for solar installations including the following:
- They increase the power output 20-30%, which leads to higher ROI and faster payback time
- They reduce the levelized cost of energy (LCOE) by 5-15%, thus increasing the competitiveness of the installation
- They can actively respond to storm threats such as hail, and move the panels into a safe position, thus protecting the solar installation from catastrophic loss
- They can help solar installations qualify for several different tax credits in the US, which were increased and extended from the Inflation Reduction Act
Combined with strong underlying growth in the solar energy market, these characteristics point to over 20% market growth over the next decade, according to various industry estimates.
Improvements since the short pitch:
In Mason's short pitch, he identified several key issues which have since played out.
First was downside from the solar Investment Tax Credit (ITC) step down and scheduled expiration in 2022, which had likely pulled forward orders and would lead to a revenue decline. Since then, the Inflation Reduction Act extended the ITC through 2034, with a 30% credit available through 2032.
Second, he pointed to unsustainable gross margins. Indeed, gross margins fell from 23% in 2020 to 8% in 2021. Fantastic call on Mason's part here. However, since then, gross margins improved to 13% in 2022, and rebounded to 26% in 2023. Going forward, Array targets mid-20% gross margins before benefits of various tax credits, which could boost margins to over 30%. Array's mid-20% gross margin target is the same range its larger competitor Nextracker seeks to achieve.
Third, he pointed to Array's poor international exposure. Since then, Array acquired the 4th largest player in the space, STI Norland, which was the leading European player, and also brought significant Latin America exposure. Now Array has increased its international exposure and competitiveness.
Fourth, he pointed to Array's technology gaps versus Nextracker. The two companies have pursued different technology approaches, with Array using single motors for multiple rows, and Nextracker focusing on a single motor for each row. Both systems have various advantages and tradeoffs, but for irregular terrain, Nextracker's system is better. With Array's acquisition of STI Norland, Array improved its competitiveness in this aspect, because STI Norland has a dual-row tracking system.
Fifth, he pointed to heavy insider ownership with Oaktree and Array's founder, which collectively still held 28% of shares outstanding. These owners don't appear anymore...
Sixth was the upcoming FLEX spin of Nextracker into a public company, which would reduce the scarcity value of Array. Nextracker went public in Feb of 2023, and trades at a 100% premium to Array today (on CY 2025 estimates). Nextracker is a great company, and valued for it.
A few months after Mason published his short pitch, Array missed and withdrew its 2021 guidance amidst "unprecedented" rise in costs. If you read through the comments on the short pitch, you will see that another likely weakness of the company at the time was its management, which were not known for being conservative.
Since then, new management has taken over, and results have clearly improved with the rebound in gross margins, multiple successful cost-cutting efforts and supply chain improvements. It seems the current management is also more disciplined and intent on maintaining prices amidst a competitive market.
Valuation:
Array appears objectively cheap for its growth and quality characteristics. It trades at 9.4x consensus 2025 earnings, which are expected to be up 34% from 2023 levels. Its 3-year earnings CAGR (2023 to 2026) is expected to be 17%. Given industry growth estimates of 22-25% through the early 2030s, this above-market growth should continue for some time. Array is not excessively levered, at 1.5x net debt/ebitda. And it generates reasonable returns, with a forward ROIC of ~11% and an ROE of over 20%.
It's useful to compare its quality to Nextracker, which is priced at 18.8x 2025 earnings, a 100% premium to Array. Nextracker is indeed likely the better company, with better and more consistent growth, but Array is much more similar to Nextracker on fundamentals than this valuation gap implies. Both companies target core gross margins (before tax incentives) in the mid-20% range, and are delivering similar margins today. Market shares appear to have been fairly consistent over the past few years, with some gains and losses at various times. Array claims to have made material market share gains in 2022, but these were likely from smaller competitors rather than Nextracker, and likely gave up some share early in 2023 when it held firm on pricing. In the last few months, Array has reported win rates which lead it to believe it is again taking share while maintaining the same price and margin discipline. Meanwhile, Nextracker commented in its January Goldman Sachs conference that it has held 30% global share relatively consistently over the last 5 years. Net-net, it does not appear that Array needs to accept lower margins in order to maintain market share versus its largest competitor.
With Array's substantially superior earnings growth prospects versus the market, and reasonable quality characteristics, it seems it should earn some premium to the market. If we discount the long-term forward earnings multiple of the market (I'm using the 10-year average of 17.7x, which is a few multiple turns below the present market multiple) two years forward, we get around 14.4x. Applying this to 2025 consensus earnings results in a fair value target of $22-23, or nearly 60% upside. Array may be slightly lower in quality than Nextracker, so I wouldn't argue it deserves the same multiple (or 100% upside), but 60% upside seems fair to me given its growth prospects and returns.
Recent weakness:
Last year, Array was impacted by multiple project push-outs due to permitting, interconnection, and supply chain delays from its customers, which led it to reduce guidance a couple times. It also faced pricing pressure in the first part of the year when it decided not to chase other competitors (seems like smaller ones, rather than Nextracker). While bookings have accelerated since then, the pushouts from last year will impact early 2024 results, leading to an expected 16% decline in revenue in 2024 from 2023 levels. The revenue decline is also partly due to commodity price declines. Q1 of this year is expected to be the trough, with significant growth thereafter. Despite the decline in revenue, the company has guided to growth in absolute EBITDA dollars for the full year, which comes on top of record numbers for 2023. These pushouts appear to be industry-wide, but Nextracker appears to have a deeper base of customers and has done a better job moving projects around to avoid the same impacts.
With $900 mm of orders in the second half of last year (versus total revenue for the year of $1.6 bn), and a book-to-bill ratio of 1.7 last quarter, it appears that the decline in revenue in 2024 will be the exception to the trend, but these disappointments have clearly weighed on the stock this year.
The results of the next couple of quarters will be critical to establishing confidence that the growth issues from last year were temporary.
Sources for more info on tax credits and market growth projections:
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
- Delivering on guidance for 2024, especially the return to growth projected after the expected Q1 trough.
- Maintaining margins and bookings growth throughout 2024 despite competitive pressures.
- Additional regulatory clarity around certain tax credits which may expand the number of Array's components that qualify.