A Walkthrough of How I Valued Canadian Solar
A disclaimer, I am not a financial advisor and my comments should never be taken as financial advice. Investments come with risk, so always do your research and analysis beforehand.
In my previous articles regarding Canadian Solar I explained my process for getting familiar with a company, and my process for determining if I want to invest in a company. In my most recent article I forecasted the financials of Canadian Solar in order to put an intrinsic value on the company. I also looked at Canadian Solar’s value relative to its competitors. In this article I will explain the steps I took to value Canadian Solar and compare it to its peers.
To value Canadian Solar I modeled pro-forma financial statements, I projected these 5 years in the future and I performed a discounted cash flow analysis. Turning actual financial statements into pro-forma statements, simply involves adjusting for one time expenses, and simplifying the statements. It is my personal approach, to make financials more readable, to combine lines if doing so would not have any material impact. For example I combined “investments in affiliates” and “pre-paid land assets” in “other long term assets”. Projecting financials is a bit more complex, however I will give an overview here. The most important things in projecting financials in my mind are revenue assumptions, cost figures, and net spending on balance sheet items. To project revenue I broke Canadian Solar down by product. When management gave product targets, I used them and extended historical trends in price. When there were not product specific targets I instead used a historical growth rate. For costs, I used historical trends in costs, and or the historical average profit margin on each product. Finally, I based Canadian Solar’s future assets and liabilities on management targets for capex, and growth rates consistent with cost or revenue increases.
After projecting the three financial statements, I performed a discounted cash flow analysis (DCF). To do this, I start with projected EBITDA and subtracted taxes, capex spending, and changes in working capital. I then discount this value, called unlevered free cash flow, by the firm’s cost of capital. I take a sum of the present value of future cash flows, and this is part of the firm value. The other part is the terminal value, or the value of the firm’s continuing operations. I use the exit multiple method first. This assumes the continuing value of the firm is summed up by the firm’s market price. In this case I use EV/EBITDA. I multiply Canadian Solar’s EBITDA by its competitors’ average multiple. I discount this value by the firm’s cost of capital. And add it back to the sum of the present value of future cash flows. I also use the Gordon growth method. I took the year 5 cash flow, and had it grow forever at a rate of 1% a year. I then discounted this value. Adding this discounted value with the discounted cash flows, you get another value for the firm. Using the exit multiple method value and the Gordon growth value it is possible to develop a valuation range. It is good practice to also look at comparable company ratios to make sure that a valuation makes sense.
Finally, to compare companies, I pull their financials from SEC EDGAR, I adjust their financials for one time expenses, and I then compute the financial ratios. I then take an average of certain ratios to determine a valuation.
I hope this was a helpful glimpse into my methodology, and that the process I take is more understandable. I did not mention things like weighted average cost of capital calculations as well as enterprise value to equity value calculations for simplicity. Finally, I did not mention specific decisions in my financial model, but if there are questions, I would be more than happy to answer them. As always, ask any questions to @robbieb on Invstr, and follow for more market analysis.
More Specifics
To forecast revenue, I broke the two main business lines down by product. In the MSS segment (Solar modules, services, and components), the main revenue driver is solar modules. I used management projections and historical growth rates to project the MW sold per year, and the average price per year. The price is quite difficult to forecast as prices have dropped as much as 20% in a single year. For solar kits, EPC services, and all other revenue I take a historical percentage of solar module revenue. For solar kits and EPC services, I have the percentage of solar module revenue grow as management has projected. For the Energy segment (selling solar projects, operating solar projects, and solar project services), the main driver is selling solar projects. Management gives targets per year that they expect to sell. I use these projections and took a historical average of the selling price per MW of solar power, to put a price on these projects. Management also provides estimates for how many MW of solar projects they expect to operate per year and collect electricity revenue on. I use their projections and average revenue per watt of solar project operated. And for other revenue I just use a percentage of solar project sales. To forecast costs I projected costs per module when applicable and applied a historical margin when not applicable. For SG&A I again used a historical margin. For depreciation, amortization, interest expenses I modeled schedules. This means I granularly forecasted these expenses per type of debt or asset. For taxes I used last year’s tax rate, and I then arrived at net income.
For the balance sheet, I mainly kept accounts as a percentage of revenue of costs, however capital expenditures were based off management projections. I projected debt based on Canadian Solar’s debt maturity schedule. And finally, the cash flow statement accounts for all the balance sheet changes. In my model the company does hoard cash. This is either due to over optimistic management projections in revenue generated from capex spent, or that the company can begin to pay dividends or expand. One last thing to note, is that I did adjust some management projections based on news, current events, sentiment among financial analysts who cover Canadian Solar.
Vocab
Terminal Value- The value of the busines beyond the projected cash flows.
Exit Multiples- Assuming that after the 5-year forecast period, the company is sold at public market valuations. We then use financial ratios to value to company. And we discount that sale value to present value.
EBITDA- earnings before interest, taxes, depreciation, and amortization.
Solar Module- A solar panel.
Unlevered free cash flow- EBITDA- taxes- capital expenditures – changes in working capital
Discounted cash flow- We take the value of a firm to be the present value of its future cash flows.
Present value- We take each future dollar of cash flow and we discount it so that you would be indifferent between receiving a dollar of future earnings, or that dollar discounted to the present value.
Discount rate- The discount rate is the weighted average cost of capital. A discount rate is the rate of return that you would give up by taking the discounted cash flow today, versus the full value in a year.
