Shares of SunPower (SPWRA) are suffering on Tuesday morning as they disclosed a review of “unsubstantiated accounting entries.”  Of course, the stock is down nearly 18% just after the open on Tuesday as many investors are headed for the exits.  We cannot blame those investors for dumping shares right now because any time accounting principles are questioned it can be very hard to regain lost credibility.  Financial markets rely on the integrity of financial data, and any accounting crisis inherently brings a lot of uncertainty.  Most investors will automatically assume the worst and past experiences with the likes of Enron and Worldcom have show the need for caution.

According to SunPower, the issues were identified in an internal investigation of their Philippines manufacturing unit.  There are issues in their accounting for cost of goods sold and and which years these costs should be counted towards.  It is believed that cost of goods sold were overstated by $1 million in 1Q of this year, but were understated by $14 million in 2Q and $2 million in the third.  The results for the last two years will likely need to be amended once the investigation is complete.  Furthermore, the guidance for the year ahead cannot be relied upon as it is subject to change as well.  If there is one thing we know, it is that the market hates uncertainty.  Analysts have downgraded from bullish ratings at Piper Jaffray (PJC) and FBR this morning, and more may be on the way.

At Ockham, we do not think that the errors in the low tens of millions over the course of a few quarters are a huge concern as far as we can tell.  That being said, there is no excuse for accounting mistakes and it calls into question the company’s recent performance.  So, even though we have our most bullish Greatly Undervalued valuation stance on SPWRA, we would wait for more clarity on the situation, which the company hopes to bring to the market in the next 30 days.  As we always say, valuations cannot be looked at in a vacuum and should be only one factor in stock selection.  Accounting issues will always spook investors even if the amount involved seems insignificant.

Thursday evening solar energy technology firm SunPower Corp. (SPWRA) reported second quarter results that blew away the expectations.  Industry analysts were calling for earnings per share of $.13 on revenue of about $263 million, but the results came in at EPS of $.24 on sales of $298 million, growth of 39% sequentially.  The biggest driver of growth was the components division which boasted a 75% sales gain over the first quarter with particularly strong performance among residential and light commercial consumers.  The stock is up well in excess of 20% after the impressive results as well as an upgrade from FBR.

Not only was this quarter’s performance encouraging to Wall Street, but the company also raised sales guidance ahead of full year expectations.  They are now expecting fiscal year sales totals to be somewhere in the range of $1.35 billion to $1.7 billion.  Revenue for the last fiscal year were $1.43 billion, and growth in this market environment would be a rather compelling.

Alternative energy companies, in general, have had a hard time bringing costs down enough to make the technology profitable.  Many of the stocks that could be characterized as “green tech” have traded more on growth potential than actual fundamentals.  SunPower is the complete opposite of that broad industry characterization, as they have turned a profit in each quarter for the last 4 years.  Of course, the company saw its best quarterly performance when crude oil prices were reaching record highs in 2008, and consumers were looking for any alternative that might be cheaper, and if it is “green” then that was gravy.  This last quarter SunPower greatly exceeded estimates even with oil prices much lower, which suggests to us that management is able to deftly navigate various market conditions. 

We continue to believe that SunPower is Undervalued based on the awesome sales growth over the years and consistent earnings of this well run company.  Sales have not grown at the breakneck speed that they did in the first few years, but it is a more mature company now and cheaper oil being a major headwind we are not surprised.  Over the long term, there is a trend to diminish the role of fossil fuels and move towards more renewable energy, which at this point should not be a surprise to anyone.  If a long term investor is looking to ride this trend, then he/she could do far worse than to choose a company that has shown the ability to stay fundamentally strong from quarter to quarter, year to year.  The company has used the recently more hospitable capital markets to improve the strength of their balance sheet, issuing equity and convertible debt in May.  The company now stands with more than $450 million in cash on hand, or about $5 per share.

After the substantial move that the stock has seen today, this is not the optimal time to invest resources.  However, SunPower remains attractive compared to its peers on a fundamental basis and we see it continuing this positive momentum through strong leadership.  If there is a pull back of profit takers after today’s advance, then there is an opportunity for long term investors.

Applied Materials (AMAT) is not only an industry leader in the production of technologies related to capturing solar energy, AMAT is also leading by example in recently converting its corporate headquarters to run on solar power. On September 19^th, Applied Materials in conjunction with SunPower Corp. (SPWR) completed two solar power systems at AMAT’s corporate headquarters in Santa Clara, California. While the project is clearly self-serving to AMAT, the nation’s largest solar powered corporate office could serve as a model for others to follow. Clearly, Applied Materials has become far more than a semiconductor company since entering solar in 2006.

The costs of such a system were not made available, but clearly AMAT took advantage of the federal investment-tax credit aimed at spurring investment in alternative and renewable energies. This tax credit (as political observers know) is set to expire at year’s end, but no matter who gets elected in November; energy will be a major issue. There is a strong possibility that the next administration will enact some form of program to deploy more energy alternatives, in hopes of achieving the oft-mentioned “energy independence”. Applied Materials would undoubtedly benefit from the extension of such a policy.

It is not just America that is clamoring for alternative sources of energy. The developing world is hungry for energy as well and large solar projects are already underway in India and China. A report by GreenTech Media and the Prometheus Institute predicts that the thin-film solar industry is expected to double each of the next 3 years!

We are not saying that solar energy will either make us “energy independent” or in fact become the most cost effective source of alternative energy, but to us it seems to be an industry that has great potential for growth. We touted AMAT as Undervalued back in March (Applied Materials: Going Green) at a price just below $19 because we saw increasing revenues and growth looked positive. We believe that now at near a ten year low price of below $13, this stock is Greatly Undervalued. This stock is a prime example of one that is being dragged down unfairly in a difficult market because the company continues to report sales growth and positive earnings. As of the last quarterly report, management expects fourth quarter revenues to be up 2%-10% and orders are expected to increase 5%-10%.

At Ockham Research, we understand that it can be difficult to invest in any company right now, but as the saying goes, “be greedy when others are fearful.” It is impossible to deny AMAT is cheap right now when compared to what the market has historically been willing to pay for the shares. For example, over the last ten years AMAT has traded between 2.6 and 5.0 times sales, but the stock is current well below this range at a price-to-sales of 2.0. Furthermore, AMAT’s price-to-cash flow is currently 10.4, while this stock has historically ranged between 17.2x and 31.3x. So, for Applied Materials to trade within these historically normal bounds, the stock would need to appreciate to at least $22. That being said, these are not normal times and it may take some time before the market again recognizes the underlying value of such a company.