American Superconductor's recent rapid growth from wind turbines relies heavily on a single Chinese customer, whose inventories seem to be rising.
Greg Yurek kept American Superconductor aloft through two decades as a public company, searching for a profitable market for its high-power wire. The company rode the dot-com surge to a $75 share price, then back down to $3.50 as it amassed $400 million in losses and one of the Nasdaq's highest short interests.Also at Barron's
Four years ago, the superconductor specialists bought an Austrian firm called Windtec that designs wind-turbine generators. Now, sales are growing at a 70% annual clip, to an expected $450 million for the fiscal year ending March 2011. AMSC supplies China's leading wind-turbine maker in that nation's construction of a great wall of wind power. The stock now trades at $33.48 (ticker: AMSC), valuing the Devens, Mass.-based business at $1.5 billion—equal to some 50 times trailing 12 months' earnings and 23 times cash flow.
Yurek's persistence has been rewarded. "It's growth, growth, growth," says the chief executive, who co-founded AMSC in 1987. "Our revenues are going to continue to grow, going forward. I don't see any slowdown."
But the optimism in Yurek's outlook, and in AMSC's high valuation, may be giving insufficient weight to signs that China's boom in wind power is slowing. Wind farms stand idle because the power grid doesn't yet reach them. An industry of well-capitalized wind-turbine makers has arisen with the collective capacity to more than satisfy their nation's needs; in consequence, prices are dropping while receivables and inventories pile up on manufacturers' balance sheets. These worrisome trends are all visible in an initial offering prospectus just filed on the Shanghai exchange by Sinovel Wind Group, the turbine maker that has accounted for almost 80% of AMSC revenues.
As shown on the left side of the nearby graph, Sinovel's production has steadily outstripped its sales. Sooner or later, Sinovel will have to rationalize its levels of production and inventory—and in turn, its voracious purchases from AMSC. That risk isn't priced into AMSC shares.
More, More, MoreAMSC's big client, Sinovel, has been producing more turbines than it sells, causing inventories to rise. Small turbines dominate sales.
Wind power contributed 97% of the $367 million in revenue that AMSC reported for the 12 months ended September, with earnings of $29 million, or 64 cents a share. AMSC bought Windtec in early 2007 for an initial $12 million in stock and an earn-out that lifted the total cost to $51 million. AMSC Windtec licenses "build your own wind turbine" designs to manufacturers. When those customers start up their factories, they purchase the electronic control systems for each wind turbine from AMSC.
Customers who have licensed Windtec's designs include Korea's Hyundai Heavy Industries and India's Ghodawat Energy. But it is Sinovel that put AMSC into the black.
China has big plans for clean energy. This month its government will present its 12th five-year-plan, which aims for 180 gigawatts (billions of watts) of wind installations by 2020. Domestic production has grown so fast in just five years that the country has already blown past the 30-gigawatt goal for 2020 that was set back in 2007. China installed more wind turbines last year than the U.S. State banks and utilities have nourished producers like China Ming Yang Wing Power Group (MY), which recently debuted on the New York Stock Exchange, Dongfang Turbine, and Goldwind (002202.Shanghai or 2208.HongKong). The largest, with a 25% domestic share, is AMSC's partner Sinovel.
On Friday, Sinovel got state approval for its $525 million initial public offer. It also has a $6.5 billion commitment from a Chinese bank. According to the prospectus, sales grew about 70% in the first half of 2010 and new contract awards have built its backlog to 10 gigawatts worth of turbines.
But as fast as Sinovel has grown, the prospectus shows that its production has outpaced shipments by about a third. Consequently, as the right side of the graph shows, average inventories piled up in the six months ended June to more than 270 days' cost of materials. The Chinese prospectus reports Sinovel's purchases from AMSC for last few years, and those numbers roughly track the sales to Sinovel reported by AMSC. The only exception is the first half of calendar year 2010, when Sinovel shows some $70 million worth of purchases. AMSC reported selling about twice that amount. The prospectus also shows that Sinovel has been buying electronic-control systems from another company.
The Bottom LineAMSC's pricey shares look overvalued because of its reliance on a Chinese wind-turbine maker, whose production outpaces sales.
"We don't see any issues there," says AMSC's Yurek. His electronics will be in the bigger turbines that Sinovel is planning for China's offshore wind farms. Within five years, Sinovel aims to be the world's leading turbine maker.
Now that Sinovel plans to go public, AMSC investors can see if that growth matches AMSC's towering valuation.