TPI Composites: Undervalued Exposure To Secular Growth With This Small Cap – TPI Composites, Inc. (NASDAQ:TPIC)

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Investment Thesis

TPI Composites (TPIC) is the absolute leader in its industry with best in class technology and unmatched global footprint and is serving most of the global market. TPI’s line of business has an attractive combination of macro tailwinds and a favorable shift in wind blade industry dynamics as well as growth optionality. Valuation of TPI is near historic lows due to transitory issues making it fall out of favor with investors. We think that good execution in new manufacturing lines leading to higher margins in the short term and diversification efforts in the long term will cause the stock to rerate. We view TPIC as an optimal risk/reward play in the renewable energy field and recommend investors Buy.

TPI’s Business

TPI is the globally leading wind blade manufacturer. It is the only blade manufacturer with the global scale with facilities in 6 countries strategically optimized for regional industry demand (USA, Mexico, Denmark, China, Turkey, India). Its products are defined by high quality and low price compared to in house produced blades of OEM’s, thus leading to higher efficiency of lower cost per watt and levelized cost of energy (LCOE).

Its differentiated products brought TPI immense growth of 37% top line and 52% EBITDA CAGR from 2013 to 2018. Recently, however, its growth slowed down to ~8% YoY in 2018 as it shifted its strategy to profitability. It is guiding for revenue growth of ~43% in 2019 and another ~22% on top of that in 2020 thanks to new manufacturing lines picking up. Its profitability strategy is reflected in the EBITDA guidance of 21% growth in 2019 and another huge ~119% in 2020 (Source: TPI 1Q19 Earnings Call Presentation). If the management can execute well, the financials will be very different in two years.

TPI’s best in class production quality has brought it industry domination with it serving 5 customers of the global top 7. In fact, TPI customers hold 56% of global and 90% excl. China market share (Source: page 6 Wood Mackenzie, “Historical Global Wind Turbine OEM Market Share” TPI Investor Presentation – June 2019).

TPI is also differentiated by its competitors with its close customer relationship and its dedicated supplier model. This method both increases loyalty and enables stable long term revenue. Its model is based on sharing the workload in investment and production with high quality, low-cost blades built to customer specifications. This model allows high capital efficiency due to revenue visibility with long term contracts which currently secures $6.3 bn of revenues to 2023 (Source: TPI 2018 Annual Report).

TPI is working to diversify its business through leveraging demand for lightweight composites in transportation and aerospace industries. These industries present huge market opportunities and would expose TPI to new areas of secular growth.

Wind is a Secular Growth Trend in Energy

Wind has been one of the fastest growing sources of energy in recent years. Installed wind capacity grew rapidly, with a ~22% CAGR from 2000 to 2018 (Source: BNEF). The growth is expected to continue with 50% of world electricity being generated from wind and solar by 2050 (Source: BNEF) up from 5.6% in 2016 (Source: IEA).

One of the two main factors driving wind energy demand is government policy. US has set multiple initiatives in place. Thanks to Wind Production Tax Credit new American turbines as well as renewals that begin work before the end of 2019 will have strong tax incentives (Source: Department of Energy). These incentives may be longer lasting than initially thought with some politicians looking to extend the deadline (Source: Bloomberg). IRS legislation further boosted by widening the benefits of the law to a wider audience, affecting incomes up to 2023 (Source: IRS). Individual states have also been very active in revising their Renewable Portfolio Standards, increasing programs and targets for wind (Source: National Conference of State Legislatures). The EU, being the most progressive global organization, has set an ambitious goal of 32% energy production share for renewable by 2030 being an example to the world (Source: Reuters). China is also on board and is the leading global wind producer targeting 210 GW of grid-connected wind energy capacity by the end of 2020. Much like all things China, its wind production capacity is growing very rapidly; its capacity was at 187 GW beginning of 2018 (Source: Singularity Hub). These initiatives are affecting business goals with ~50% of Fortune 500 companies setting carbon emission targets (Source: Climateaction.org) and are calling for regulators to act more (Source: Environmental Defense Fund). The tectonic shift to renewable is apparent across almost all decision makers and will continue to shape the future.

Second major driver for wind is low and decreasing LCOE for onshore production compared to other sources. Thanks to technological advancements, global onshore wind LCOE demonstrated a dramatic increase in production efficiency with a 69% decrease over nine years from 2009 to 2018 (Source: TPI Investor Presentation – June 2019 ). The cost is the main driver of consumer behavior. Lower renewable costs over time will disproportionately affect renewable demand as most consumers will choose to be “green” at a similar cost.

Wind Blade Market is Evolving Favorably

TPI benefits from the trends within its niche in addition to the growth of overall wind energy. The wind blade market is evolving into a predominantly outsourced one, driving demand for TPI. Wood Mackenzie calculates that share of outsourced wind blades grew from 38% of the global wind blade manufacturing in 2009 to 59% in 2018 (Source: page 16 of TPI Investor Presentation – June 2019 ). This ongoing shift in OEM behavior is driven by lower costs and the need to drive lower LCOE as well as talent constraints. As blades are one of the most costly parts of a turbine, making up ~22% of total installed cost, they are one of the first to be addressed in any restructuring agenda. TPI significantly benefits from this trend with its global footprint and low-cost base; it managed to grow its blade manufacturing market share 4 fold in 5 years from 2013 to 2018 (Source: Wood Mackenzie, American Wind Energy Association, page 17 of TPI Investor Presentation – June 2019).

TPI benefits from the need to drive lower LCOE’s, in addition to more outsourcing, with a growing market thanks to shift to longer blades. Longer blades dramatically increase efficiency (Source: NYT) and have one of the largest impacts in reducing LCOE’s. Estimates calculate that share of blades lower than 60 m will decrease from 64% of the total market in 2018 to 41% in 2022 (Source: p 17 TPI Investor Presentation – June 2019). The shift to longer blades will increase revenues with their higher selling prices on new blades as well as creating new revenues with replacements.

Diversification Optionality

Despite the strong growth trend in wind, TPI is looking to diversify and is exploring new industries. Its diversification strategy emphasizes clean transportation and aerospace as priorities citing demand for lightweight composites in those areas. This is a solid strategy as both of these are high potential and high growth markets driven by secular trends.

Growth in clean transportation is driven EV adoption. BNEF estimates that 55% of all new car sales and 33% of the existing fleet will be EVs by 2040 (Source: BNEF). One of the greatest challenges facing EVs is battery life and range. Lighter vehicles aid this cause as lightness equates to longer range and fewer batteries. TPI’s composites are lighter than traditional materials. TPI’s clean transport initiative is slowly picking up steam with it entering a new agreement with Proterra, a leading producer of zero-emission heavy-duty vehicles, to be the supplier of composite bus bodies for zero-emission electric buses (Source: TPI). TPI is in the right area of clean buses with Frost & Sullivan estimating that the global annual e-bus market will be +32,600 units by 2022 with US leading the way (Source: Frost & Sullivan).

Aerospace is another savvy move by TPI with aerospace composites market estimates point to a ~$43 bn market by 2022 showing ~10% CAGR growth (Source: Marketsandmarkets). Aerospace manufacturers are attracted to TPI’s solutions due to lower cost compared to traditional products (aluminum, carbon composites, etc.). TPI showcases this shift with the example of materials used in the new Boeing 787 vs. the older 777. The 787 is ~50% composites and 20% aluminum while the 777 is 12% composites and 50% aluminum (Source: page 27 on TPI Investor Presentation – June 2019). This trend will most likely continue with new airplanes.

Valuation is Very Attractive

The current valuation is the lowest it has been in a long time. The equity is trading dirt cheap given management guidance with 0.44x 2020 sales and 5.1x EV/ 2020 EBITDA. We view this as unwarranted given the aforementioned attractive market dynamics and growth levers.

We would approximate fair value for this stock at least 7x guided 2020 EV/EBITDA yielding $1.3 bn market cap and +55% upside assuming same net debt and share count. We understand that this is a premium to history but argue that it’s warranted due to the expected growth.

The Pullback is Unwarranted

TPI experienced an almost 30% drop to date from its February 5th pre-announcement. This drop was mainly due to their reduced revenue and EBITDA guidance for 2019. Revenue guidance was decreased to $1.45-$1.5 bn from $1.5-$1.6 bn and EBITDA fell to $80-$85 mn from $120-$130 mn (source: TPI Investor Presentation – June 2019 ). Three unfortunate events happening simultaneously caused this revision: 1) Senvion’s (a customer with 4% of TPI capacity) financial difficulties, 2) A worker strike in Matamoros in Mexico, and 3) PET supply issues. The Q1 2019 earnings call transcript (Source: TPI 1Q19 Earnings Call Transcript) is useful in understanding what is going on.

Senvion entered self-administration process in April 2019 which will have a $16 mn effect on TPI’s 2019 EBITDA guidance according to the management. Despite the opportunity to sell all the wind blades produced for Senvion directly to the wind farm owners pursuant to their step-in-rights, TPI lowered guidance to be safe. Senvion currently represents 4% of TPI’s total global wind production capacity. TPI did not change 2020 guidance as they cited a busy pipeline that they can draw from if need be.

Many of the unionized TPI workers in Matamoros, Mexico reduced production in Q4 2018 and Q1 2019 and eventually went on strike in February of 2019. The disruption in production and the significant loss of workers due to actions taken by company management had a profound impact on results. The 2019 EBITDA effect of the losses is estimated to be $25 mn. TPI views this as a temporary disturbance and expects full volume production in Matamoros in 2020.

TPI struggled with finding PET material causing production problems. This was due to many manufacturers shifting to PET at the same time and supply of PET not keeping up with demand. Management views this as a temporary issue, however, with both new PET supply coming online and use of other materials instead of PET.

All of these issues happening simultaneously caused investors to doubt foresight and execution of TPI management and created a selling spree. We view these issues as temporary and the sell off as an opportunity. We have full belief in execution excellence and strategic vision of TPI management. We think that reaching provided guidance of top-line growth and massive profitability will cause investors to pile back on during H2 2019 and 2020.

Risks

Customer concentration is very high with Vestas 46%, GE 27% and Nordex 13% of dedicated lines. Any fallout with one of these would be a massive problem for TPI. Long term contracts, however, protect this from happening and give TPI time to backfill in an unexpected fallout. The scale and stability of these companies also decrease the potential of such an event. TPI’s diversification strategy will reduce the revenue impact from any one customer over time.

The risk of competition comes to mind but is very low. TPI is the market leader serving almost all of the big players thanks to its advanced technology. The structure of TPI’s relationship with customers, collaborative approach, build-to-spec blades and long-term contracts, increases customer stickiness, and switching costs. It would be very unlikely for a competitor to steal TPI’s business.

Policy risk is an issue for any company with operations dependent on US government incentives under the current administration. US can change policy on a dime, much like the withdrawal from the Paris Agreement. We, however, view these shifts as short term populist actions and that the longer term trend is “going green”. We think that fighting climate change is a permanent theme along with supporting the growth of renewable energy.

TPI is exposed to geopolitical risks with its operations in emerging markets like Mexico, China, and Turkey.

Trust in management and TPI’s trading multiple could further deteriorate if PET supply shortages continue or TPI has another procurement issue.

The stock is illiquid and may cause large volatility in price in an unexpected negative event, potentially magnifying the amplitude of other risks.

Conclusion

Overall we view TPI as an excellent risk/reward play and recommend investors Buy. The main business is in a secular growth market and a favorably developing niche. The management has a solid strategy of growing TPI organically both in wind blade manufacturing and diversifying into other secular growth markets. The top line growth will be matched with a dramatic jump in profitability. In our opinion, the valuation is very pessimistic and will soon change with new lines contributing to top and bottom line growth in 2019 and 2020. We find the current “dip” in price is caused by temporary factors and recommend that investors take advantage.

Disclosure: I am/we are long TPIC. 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.

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