All US-listed Chinese solar companies are manufacturers of the solar products. Most are vertically integrated, in some cases with equal capacities of wafers, cells and modules. Some use the benefit of the value chain optimization offered by specialized companies. Solar module is the final product of vertical integration. Possibly the most evident exception to the above operating model is Canadian Solar (CSIQ), a company which in addition to manufacturing, operates in the engineering, procurement and construction (EPC) space. To some degree, JinkoSolar's (JKS) activities in China and ReneSola's (SOL) in Romania and Bulgaria place both companies in the same neighborhood with CSIQ, but the size of EPC commitment makes Canadian Solar unique among the US-listed Chinese companies.
In 2013, the solar industry is working through the depression period of the last two years, caused by overcapacity and price erosion. There is a well-defined global demand, including the hot spots of Japan, China, and the US. All those regions, complemented by emerging markets, are expected to substitute for the decline of the EU demand and possible impact of tariffs.
In China, the capacity landscape is also changing. The bankable levels of module capacity, including US-listed companies, are in the vicinity of 30GW. This is against 2013 market potential of 37 to 40GW. Pressure from the EU tariffs and the need to reach minimum price with limited volume for the EU exports is expected to strengthen the further presence of the financially strongest companies.
In combination with the already-major 70 to 80% penetration of international markets, supply chain utilization has been between 80 to 100% for many discussed companies. This is in contrast to 2012 levels, and it is important since high utilization lowers costs.
Processing cost has followed the decrease in average selling prices (ASP). However, the largest contributor to companies' operating margins was the reduction of raw material costs. Polysilicon continues to be priced at bargain levels. For all stakeholders the lesson here is that with the ASP increase for solar products, the also-depressed prices for raw materials will have a tendency to jump, affecting profit and gross margins in a negative fashion. Having this in mind, we make no effort to look for dramatic processing cost improvements during Q2.
The cost of borrowing, or interest expense, is so prominent that in some cases, these costs had eliminated gross margin wholly - or multifold in extreme conditions. The ability to pay bills is essential, and companies that cannot do so are considered as borderline insolvent.
Suntech's (STP) Chinese subsidiary Wuxi Suntech is insolvent. LDK Solar (LDK) is unable to pay for its operations and has failed to meet financial obligations on at least one occasion. Based on a recent court judgment, the company had been ordered to pay $12M in damages to a Taiwanese company in a dispute over contractual agreements. Daqo New Energy (DQ) is an extremely small organization with little to no ability to capitalize its business with the particularly low prices of polysilicon. Because of the conditions mentioned, those companies above have been excluded from this review. China Sunergy (CSUN) is also excluded, as it has not provided its results to this point.
Q1 Loss Levels and Extraordinary Impacts
Based on the above table, Canadian Solar has the least distance to reach profit. However, the company had some help due to an extraordinary item deducted from their operating expenses during Q1. This was a $30M reversal of the provision made for the dispute over contracts with LDK. Without this reversal, CSIQ would be at -13% of loss to revenue.
Forex and Fair Value of Derivatives
The above table shows the impact of financial expenses as the percentage of loss. The question could be asked whether the nature of the financial item in its scope has an aspect of continuing presence, or may not be there during Q2. In the case of Forex losses, the impact could be reduced or eliminated. The depreciation of Yen against the US dollar created losses for CSIQ, but the company offered a strategy to eliminate this impact (hedging). Needless to say, if there were no Forex loss, CSIQ would be profitable in Q1 when including the reversed provision.
It appears that if the nature of the financial items is temporary, and they are no longer present in Q2, the likelihood for profitability would improve considerably for CSIQ, JKS, and Trina Solar (TSL) as in the adjustment made for Q1 (table 3).
Gross Margin Profit
The best indicator for Q2 is an improvement on gross margin. Hypothetically speaking, what would be the necessary margin to generate profit in Q1? The table below illustrates the break-even outcome. Note that the CSIQ reversal of the $30M provision is not included.
Figures display percentages (Table 4), which are unreasonable in the current market environment. Gross margins do increase based on ASP as well as with reduction in operating costs. None of them can currently support such a wide spread between processing cost and ASP. Of course, the size of revenue growth would help with fixed costs, but growth in sales would carry selling expense up with it, while GA (General and Administrative) and R&D (Research and Development) expenses would remain fixed to a degree. Before we move on, let's factor in the adjustment of financial items influencing Q1 results.
Excluding financial impacts (Table 5), significant improvement would be observed in CSIQ, JKS and TSL once again. We will shortly refer to guidance for Q2, but we also need to consider one-time items in cost of goods sold (COGS) and operating expenses, which have lowered performance in Q1 and should not appear again in Q2.
COGS and Operating One-time Items during Q1 2013
Companies which took one-time impacts included Canadian Solar within COGS at $6.1M for underutilization during Q1, representing 2.3% of revenue. ReneSola's underutilization of poly plant in Sichuan was mentioned. Total operating expenses in the first quarter of 2013 included an accounts receivable provision of $2M for JA Solar (JASO). TSL has an asset disposal built into the COGS, which amounted to $6.7M.
Guidance and Commentary
Overall, we are proposing to remove Forex losses from the Q2 results when speculating on results. Those are treated as zero impact, but there is potential they could be positive and increase net earnings. We are also removing one-time items.
Yingli (YGE) offered no guidance for Q2 and the company has a high percentage of loss against revenue, which does not render profitability in Q2.
CSIQ guided shipments at 380-420MW and 9-11% GM. GM offers no improvement when excluding the underutilization charge from Q1. Ten percent progress on shipment potential, drawing 40% revenue from Japan (high ASP region) as guided by the company, suggests revenue growth. While not spelled out as part of Q2 guidance, the secret weapon is $180M of solar plants revenue at 20% GM, which would ensure profitability in Q2. Without it, a 5% improvement in ASP and elimination of Forex loss may cause the net loss to be in the area of $5M or 77% improvement from Q1.
JKS has guided 450 to 470MW in sales, which is 66% shipment growth. The company offered no explanation on gross margin. Assuming a 5% increase in ASP, the revenue could be in the area of $267M, bringing gross profit of $41M with a 15% gross margin. Removing the impact of Forex alone, JKS would show a loss of under $10M, or a 50% improvement.
JASO guided 430MW at the top end of the guidance without guidance on margins. The company will experience an increase in volume and an estimated 5% increase in ASP per watt for products sold. A few days ago, the company suggested shipments already being beyond 430MW. Assuming 450WM, the revenue could be in the area of $288M for Q2. The company has the potential to change gross margin to 9% during Q2 on sales of cells to Japan, and elimination (or at least reduction) of its negative module margins. Unfortunately, those improvements will only help reduce net loss to around $15M, a 50% improvement.
Hanwha SolarOne (HSOL) offered 350MW shipments guidance, or a 21% increase. The company was the only one that has experienced an increase of ASP during Q2 by some 10%. We would expect that ASP would increase, probably in the area of 2%, but processing costs certainly would fall to make perhaps as much as 5% GM (gross margin). The company is expected to have a net loss of around $28M during Q2 using the same dynamic of financial and operating costs as Q1, but with Forex loss zeroed out.
SOL guided at the top end at 720MW, including 450MW in modules. The company expects margins to change from negative territory to 5% GM. A move to modules can increase revenue by a conservative 8% per watt of all products sold. The revenue can be as much as $338M, having GM profit of $16M. Using the same percentile of operating expenses and no benefit from financial item elimination, SOL is looking at a net loss of around $28M in Q2. A change in the underutilized condition of the poly plant is an opportunity to reduce those losses. Nevertheless, this cost will remain in Q2 and is expected to recover only if full production can be run within an improved spot price setting.
TSL has guided mid-single digits and shipment to 530MW on the top end of its guidance. Expectation of ASP improvement is within 5%. If the company is able to take the operating expenses down to 14% of its revenues and eliminate Forex losses, $36M in net losses during Q2 or about 43% improvement is seen during Q2.
Based on the above calculations and estimates (table 6), even the best out of the peer group have no ability to be profitable in Q2. The closest to meet this objective is Canadian Solar, and only if the solar plant revenue is recognized, something considered to be certain during Q3 results. With so many unknown factors, liquidity concerns and impact of debt on the peer group, Canadian Solar remains one of the most effective Chinese solar companies on the US market today.