Anyone who follows the solar energy industry knows it's extremely volatile. Demand for solar modules is up and down with the wind, making revenue and earnings predictions tricky at best. In late June, STR Holdings (Nasdaq:STRI), maker of ethyl-vinyl acetates (EVA) for solar panels, revised its second quarter revenue and earnings estimates downward by 8% and 22.5% respectively, due to lower demand for solar modules in Italy and Germany. The news dropped its stock 14% in a single day of trading. Since then, it's stayed in the $14-$15 range. In this case, uncertainty brings opportunity. TUTORIAL: Fundamental Analysis

A Tale of Two Segments
STR Holdings also has a quality assurance unit, which got its start in 1973, at least five years prior to the creation of the solar business. While its quality assurance business has a long history, its revenues and profits pale in comparison. In 2010, revenues were $113 million, 56% less than solar and its adjusted EBITDA of $15 million was 87% less. As a percentage of sales, its adjusted EBITDA margin was 13.3%, almost 31 percentage points less than solar. For every $100 in revenue the solar unit generates, the quality assurance unit has to generate $331 in order to deliver an equal amount of profit. Capital expenditures for the quality assurance unit in the last three years were $22.8 million. Adjusted EBITDA in those three years totaled $55.5 million. Therefore, it spent $1 to make $2.43 while the solar business made $5.43 on the same buck. Solar might hold greater risks but it clearly provides greater rewards. The greatest risk in my opinion is management holding on to the quality assurance assets a day longer than it needs to. In the first quarter, its adjusted EBITDA margin was just 2.3%, 430 basis points lower than in 2010. (For related reading on margins, see Analyzing Operating Margins.)

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The Good News
2010 was a record year for the solar division in terms of revenue and adjusted EBITDA. While it likely won't hit $259 million in revenue and $114 million in adjusted EBITDA in 2011, it should come relatively close, delivering its second-best year on record. Its diluted earnings per share in 2010 were $1.17 and given its Q2 revision, I expect 2011 will be around $1. It's one-step backward to make two steps forward. All one needs to do is look at the growth in its Asian business to know it has a bright future. In the first quarter of 2011, the solar division shipped 80% more units to Asia on a year-over-year basis and 32% sequentially. Included in this first quarter growth were shipments to two new, large Chinese customers. Asia now accounts for 46% of solar revenue and could represent more than half by the end of the year and no later than 2012. The difficulties it's facing with incentive programs in both Italy and Germany should be resolved by then and Europe will be back on the rails. All's sunny with solar. (For more on the solar industry, see Spotlight On The Solar Industry.)


STR Holdings and Peers

Company

 EV/EBITDA

 P/E (TTM)
STR Holdings (Nasdaq:STRI)

 6.30

 11.5
Bridgestone (OTCBB:BRDCY)

 9.98

 27.3
Solutia (NYSE:SOA)

 8.26

 13.5
Dow Chemical (NYSE:DOW)

 8.58

 19.5
Corning (NYSE:GLW)

 9.48

 7.8
DuPont (NYSE:DD)

 10.60

 15.1
Valuation
Its IPO was in November 2009 at $10 a share. At the time of its initial public offering, its enterprise value was 7.5 times EBITDA. Today, it's 6.3 times. Its P/E at the time of the IPO was 16.4. Today, it's 11.7. Despite greatly improving its financial picture over the past 19 months, its valuation has diminished. Simply look at some of its peers and you can't help but think it's getting a lower valuation because of its association with solar. You can disagree all you want about the future of solar energy but the fact remains that whatever happens, STR Holdings is going to play an important role. Frankly, I would much rather invest in a business that supplies module makers than in the module makers themselves. I don't know who the ultimate winners are going to be in solar panels but I strongly suspect they are going to require EVA to prolong the life of solar cells. (For more on IPO's see, How An IPO Is Valued.)

The Bottom Line
Until STR Holdings figures out what to do with its quality assurance business, whether that's selling it or fixing the margins, there's always going to be a ceiling on its stock price and while I don't have a problem recommending it at these prices, I would caution investors to be patient. These things take time.

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