A New Light on the Horizon: Can Solar-Powered LED Maker Live Up to Its Promise?

July 26, 2005
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With the price of oil hovering around US$60 per barrel and electricity shortages looming, there has been much speculation that the alternative energy sector could be the next big thing.

A few years ago, investors hoped fuel cell technology would revolutionize the auto industry. They’re still waiting for that to happen and companies like Ballard Power Systems Inc. have been big disappointments. The trick in alternative energy is to find companies that can deliver on promises.

Victoria-based Carmanah Technologies Corp. (CMH/TSX-VEN) is a leading Canadian solar power and advanced lighting company. Listed on the TSX Venture Exchange, it has a market cap of about $100-million. Founded in 1993 by Dr. David Green, its core business is making solar-powered light-emitting diodes (LEDs).

Regular light bulbs work by running electricity through a tungsten filament, creating a lot of heat and comparatively little light. The high temperatures generated not only eat up a lot of energy but also cause the filaments to burn out.

LEDs are an improvement because they have no filaments, use less power than conventional bulbs and last more than 20 times as long, making them ideal candidates to be paired with solar panels. Carmanah claims its LEDs are ideal for harsh weather conditions and remote areas where maintenance is a nuisance.

LEDs are particularly useful in marine environments, which has been the company’s main market. The company is the exclusive supplier of the LED marine lights that the U.S. Coast Guard uses on buoys in U.S. waters.

But Carmanah is no one-trick pony. Employing nearly 200 people throughout British Columbia, the company saw its revenue increase by more than 70% in 2004 to $15-million, consistent with a historical average five-year growth rate of 68% per year. With $593,000 in net earnings in fiscal 2004, the company has also crossed the threshhold into profitability.

The company’s stock has likewise performed well — up 43% over the past year. It closed up 1 cents at $3.05 in Toronto yesterday, not far from its record high of $3.22 set last year.

In May, Carmanah made a big move for a small company, finalizing the acquisition of privately held Soltek Power Systems for $10-million. Carmanah’s main source of revenue is from LEDs, while Soltek’s core business is making the panels that power them. Soltek produced about $17-million of revenue in its last fiscal year and initially, the deal looks like a good match because the two companies share a customer base yet their product lines have little overlap.

Canaccord Capital’s Sara Elford, the top stock picker amongst Canadian analysts in 2004 according to StarMine/Financial Post rankings, put a “buy” rating on the stock when it was worth less than $1 in mid-2003. The stock has stagnated since it hit about the $3 level, but Ms. Elford still sees a lot to like in Carmanah.

The combined companies will have the larger scale needed to compete in the lucrative U.S. solar market, she notes, and the fact that both companies are headquartered in Victoria should help the integration process. “Over the medium to longer term, this is a case where one plus one should equal more than two — and the price appears right.” Putting two companies of roughly the same size together is no small feat, but for Carmanah “the good news is that `Soltek` is not broken, giving management more time than it may otherwise enjoy,” Ms. Elford notes.

Beyond the temporary blip provided by the news announcement (the stock jumped 6% in the week following the deal) the long term prognosis looks encouraging. One revenue stream that is showing particular growth is transit. In April, the company finalized the sale of 200 solar-powered bus shelters to the City of Toronto. Moving forward, transit deals like the Toronto one will be increasingly important for the company, Northern Securities analyst Martin Brichon argues. In the second quarter, he notes, transit revenues were $1.86-million, which matched the division’s sales for all the of 2004.

Overall, Mr. Brichon predicts the company’s total revenue will more than triple in two years — from $15-million last year to more than $54-million by 2006.

Prior to the deal, Ms. Elford was predicting revenue of $22.5-million this year and $28-million in 2006. After Soltek is factored in, she’s now predicting revenue could top $50-million next year.

But even the bullish Mr. Brichon still has a little bear in him, as he worries the increasingly weak U.S. dollar could spell trouble.

“Most of Carmanah’s international sales are priced in U.S. dollars, which results in lower Canadian dollar sales without an offsetting decrease in costs,” he says.

Ultimately, though, he likes what he sees. He gives the stock a “buy” rating with a target price of $3.50.

While Ms. Elford agrees that Carmanah investors could see healthy returns, her optimism is somewhat muted at the moment. She notes that due largely to the Soltek deal, costs jumped 30% in the second quarter of this year. Carmanah’s profit margin also dipped from 52% to 46% compared with the previous quarter, but she reasons the dip was caused by the increase in transit sales, which the company sells at a discount to try to gain market share.

She has a “hold” rating on the stock with a target price of $3. Mr. Brichon’s target price is 35 times his 2006 earnings estimate of 10 cents per share, while Ms. Elford’s is 33 times her 9 cents per share projection. While they both acknowledge those multiples are a tad high, given the projected earnings growth, both are entirely justifiable, they say.

All in all, Ms. Elford says, the long term outlook is good. “We continue to believe that the growth potential for Carmanah is excellent. We also believe that shares will continue to trade on the basis of this big-picture opportunity.”