Many investors might be tempted to buy TPI Composites (NASDAQ:TPIC) stock when they see its ridiculously low valuation ratios and market cap lower than its cash balance as of the latest reporting date. However, my analysis suggests that this ridiculously low valuation is fair due to multiple red flags. The company’s long-term revenue growth profile is impressive, but it looks like growth for the sake of growth for me. Revenue growth with narrowing profitability metrics looks useless to me. Having weak profitability metrics over multiple years also made the company’s balance sheet weak. The near-term outlook also looks cloudy due to the challenging environment and industry growth pace decelerating to moderate levels. All in all, I do not recommend investing in TPIC and assign it a “Hold” rating.
TPI Composites is an independent manufacturer of composite wind blades for the wind energy market. According to the company’s latest 10-K report, the manufacturing of windblade and precision molding and assembly systems accounted for approximately 92% of the total net sales for the last fiscal year.
TPIC’s fiscal year ends on December 31. The company has four geographic operating segments, where the U.S. represented only about 6% in FY 2022.
I have mixed feelings about the company’s financial performance over the past decade. On the one hand, revenue compounded at a staggering 24% rate annually. On the other hand, this massive revenue growth looks useless, given profitability metrics stagnation over the decade. This is a huge red flag to me, which might indicate something is wrong with the business model. As strong businesses scale up, their profitability metrics expand due to the economies of scale effect. The company’s revenue grew sevenfold over the past ten years, but the operating profit decreased from $1 million to -$18 million.
Looking at the balance sheet also does not add optimism to me. The company has a substantial net debt position and a high leverage ratio. The balance sheet looks weak, especially given the company’s stagnating profitability metrics.
TPIC released its latest quarterly earnings on August 3, when the company slightly missed consensus estimates. Revenue declined 16% YoY, and profitability metrics moved similarly. Both the gross and operating margins went double-digits below zero. The company faces a harsh macro environment, which weighs both on the revenue growth and the cost side of the business. It is also crucial that during the latest earnings call, the management underlined significant costs related to warranty charges. Significant quality issues do not add optimism to my analysis.
And headwinds are likely to remain severe in the near term. The upcoming quarter’s earnings are expected to be released on November 3. Consensus expects revenue to drop YoY again, with a 16% decrease. The adjusted EPS is expected to follow the top line and shrink from -$0.39 to -$0.51.
The industry where TPIC operates is expected to grow at a relatively modest 7% CAGR over the next five years. While the overall industry growth looks like a tailwind, the company never demonstrated its ability to convert revenue growth into value for shareholders over the recent years. Costs will invariably increase due to rising salaries and increasing prices of raw materials. The company’s long-term financial performance suggests that it cannot transfer the inflationary factor to its customers. With the weak pricing power, I do not think that the overall industry growth in the upcoming five years will add much value to shareholders.
The stock price dropped dramatically in 2023, with a 62% year-to-date decline. Seeking Alpha Quant assigns the stock the highest possible “A+” valuation grade due to substantially lower multiples than sector median and historical averages. I always become very suspicious when I see multiples like TPIC’s price-to-sales 0.1 ratio because ridiculously low multiples do not guarantee true undervaluation.
Therefore, I need more evidence and want to proceed with the discounted cash flow [DCF] simulation. Due to the vast inconsistency of the company’s profitability ratios, I use a substantial 15% WACC for discounting. I have revenue consensus estimates up to 2026 and expect a 10% CAGR for the years beyond. I expect the FCF margin to go above zero in 2025 and to expand by 50 basis points yearly.
My calculations suggest that the business’s fair value is close to $1 billion, which indicates significant undervaluation. However, the level of uncertainty regarding the revenue growth and the ability to expand the FCF margin is very high. The company’s weak [or almost no] profitability improvement is a big red flag dragging down the valuation. That said, I am not ready to conclude that the stock is attractively valued.
Risks to consider
TPIC generates a vast portion of its sales outside the U.S., meaning that the company faces substantial risks related to international trade. The most obvious to me is a substantial foreign exchange risk. The company’s earnings are vulnerable to unfavorable swings in foreign exchange rates. Another significant risk related to international trade is regulatory risk. Changes to trade regulations and tariffs might significantly disrupt TPIC’s operations and earnings.
Potential TPIC investors should also be aware of a massive concentration risk. According to the latest 10-K report, the company generated about 90% of its revenues from only three customers in FY 2022. The company’s financial performance significantly depends on its major customers’ financial health. TPIC’s revenue can drop dramatically if any of its major customers reduce orders or decide to switch to alternative solutions. Having a limited number of significant customers also diminishes TPIC’s bargaining power when negotiating terms with them.
According to the latest 10-K report, the company procured about 20% of the raw materials required for production from China. This also looks like a significant risk to me due to escalating geopolitical tensions between the U.S. and China. The “cold war” between the two largest global economies included banning exports and imports, which might escalate further. If this is the case and TPIC’s raw materials from China become banned from selling to U.S. counterparties, this can significantly adversely disrupt the company’s operations.
To conclude, the stock is a “Hold”. The dirt-cheap valuation should not fool potential investors because the company’s financial performance over the past decades suggests something is wrong with the business model. Delivering a 24% revenue CAGR over the decade and having profitability metrics shrinking makes no sense to me. The company now faces substantial headwinds, and recent quality issues resulting in a substantial charge to P&L do not add optimism to me.