Accumulate Trina Solar

| About: Trina Solar (TSL)

Trina Solar (NYSE:TSL) shares have recovered extraordinarily from a low of $2 in November 2012 to around $16 at the time of writing. That is, in just over a year, the stock has returned some 800%. Few would have bought at the very temporary bottom at $2, or even close to it, but a spectacular return could have gotten investing late last year anyway.

We've already introduced Trina Solar as one of the lowest cost producer in an article before so it's time for some update.

Some basic figures

  • The 12 month (trailing) revenue is $1.55B. [Yahoo]
  • The company has $448.60M in cash and $1.10B in debt. [Yahoo]
  • Cash, cash equivalents and additional cash balance are approximately $557.8 million. Account receivables increased by $125 million due to increase in the shipments. [Q3 CC]
  • Bank borrowings increased in the third quarter to $1,101.7 million, of which 965 million were short-term borrowings. Long-term borrowings decreased by $10.9 million sequentially to appropriately $136.1 million. [Q3 CC]
  • Q3 EPS surprised, instead of a loss of 14 cents, the company produced a profit of 14 cents [Yahoo]

The main reason for this spectacular recovery is, as we described in detail, the turn-around in the solar industry where demand is growing strongly on the back of large price drops. The industry has undergone significant consolidation, with bankruptcies, inventory write-offs and outright reductions in capacity.

But now, panel prices have stabilized, margins have starting to increase again and the upturn in this cyclical industry with strong underlying growth has begun in earnest. There are some factors that pull earnings in different directions:

  • Price stabilization is great for margins but as a result, demand growth will be a little less buoyant compared to the last couple of years.
  • The tightening supply-demand balance is good for capacity utilization and margins.
  • During the downturn, when there was enormous excess capacity, most companies stopped building new capacity entirely. This was one way of preserving capital in the face of negative returns. However, now that the market is tightening, many companies need to embark on building new capacity again. Luckily there is still ample spare capacity available from companies facing receivership.

Trina Solar always had a creative way of absorbing these swings. When demand exceeded their capacity, they used to outsource some production. While margins suffer (a bit) as a result, it enabled them to keep capacity more occupied and therefore probably have better margins over the cycle. Here is Terry Wang (NASDAQ:CFO) explaining this during the Q3 CC:

So when we our process cost we only calculate and for our in-house production cost and the conversion cost which that's we typically do the vertically integrated from ingots, wafer and cell module and that area will be approximately under $0.40 already. But I'm saying that with cost of sold per watt basis is $0.54 and we have approximately about $0.10 in poly, so we have some outsourcing couple of cents more. So that's you add up that's a $0.54.

So one can infer that in-house, Trina can produce panels at roughly 50 cents per watt. On first sight, that's even cheaper than the cost leader, First Solar (NASDAQ:FSLR):

We have reduced our module manufacturing cost per watt to US $0.59 from US $0.67 last quarter, an US $0.08 per watt or 12% reduction quarter-on-quarter," stated Jim Hughes, Chief Executive Officer of First Solar. [Cleantechnica]

However, this might involve comparing apples and oranges:

If we take the additional impact of excluding freight warranty and recycling cost, we would be in the low 40s, so I think that's kind of the competitive benchmark that we should all keep in front of us," Hughes continued. [Cleantechnica]

On the other hand, First Solar's Cadmium-Tellurium cells usually have a lower conversion efficiency (just under 14%) compared to the crystalline silicon cells used by Trina Solar (in the high teens), which makes Trina's panels more suitable for use in tight spaces, for instance rooftops.

And Trina has another trick, they are able to squeeze more out of their existing (2.4GW) capacity:

In past time when we talked about 2.4 gigawatts that means average is 600 megawatts each quarter. With our big improvement, we believe we can shift just about, could be 720 megawatts a quarter if everything is successful, at least we can achieve with an achieve 700 megawatts a quarter. [Jifan Gao Q3 CC]

That is a 20% increase in capacity with very little, if any, capex, and only through efficiency improvements, although it's a pity these were not explained further at the CC.

Trina Solar's third quarter
The quarter was very good:

In particular, we shipped 775-megawatt of modules beating our higher end guidance by almost 100 megawatt... module ASP and the polysilicon costs continued to stabilize in the third quarter. Furthermore, our manufacturing costs improved noticeably which allowed us to achieve a middle double-digit gross margin in the third quarter. OpEx was $77.4 million, an increase of 3.1% sequentially and a decrease of 1.2% year-on-year. [Jifan Gao Q3 CC]

  • The ASP for module for third quarter is about $0.64. [Jifan Gao Q3 CC]
  • Operating cash flow is approximately $32M. [Terry Wang Q3 CC]

There are several growth drivers going forward

  • The Chinese and Japanese markets.
  • Utility scale projects fetching higher margins.
  • The takeover of NESL Solartech.

The good news is that Trina is favorably positioned in markets that experience strong growth:

The strong demand was particular driven by China, North America, Japan and the U.K., where we have worked to further strengthen our leading positions. [Q3 CC]

Trina Solar is one of the country's largest panel manufacturers, deriving more than 25% of its revenues from the Chinese market, and we believe that it could be well poised to improve its shipments as the market expands. [Trefis]

According to a Quartz report, business in China will also account for as much as 30% of Trina's revenue in 2013 - up from 13% in 2012. Their Japanese sales are also growing fast and the added benefit is that the ASP in Japan tends to be higher:

Currently, Japan contributes 11% of total revenues, a substantial increase from 6% in quarter two 2013. [Zhiguo Zhu, Q3 CC]

Europe, which used to be the leading solar market (more especially Germany), but growth is tapering. Europe constitutes only 21% of Trina's output. A dynamic part of Europe is the U.K. constituting 7% of Trina's output.

Guidance For Q4 and the full year 2013 is:

For the fourth quarter of 2013, we expect our shipments to be between 660 megawatt to 690 megawatts and overall gross margin to be in the middle teens in the percentage terms. We also revised our guidance for total PV module and system deliveries upwards to between 2.58 gigawatts and 2.62 gigawatts for the full year of 2013. [Terry Wang CFO Q3 CC]

This is an important, and growing part of Trina's business because it normally generates higher margins because:

it allows them to capture additional value by providing solar panels along with other balance of systems equipment and the related engineering, procurement and construction services. [Trefis]

Here is Terry Wang on the typical margins of these projects

And again that the project typically more than 20%, 25% of gross margin will help us if we continue to deliver on schedule our pipeline project. [Terry Wang Q3 CC]

Trefis believes that the rising importance of these projects could rise the ASP to around $0.82 per watt. Next year could see quite a rise in these utility scale projects. Here is Jifan Gao during the Q3 CC:

So in other words, we could build 100 megawatts in the first quarter and now it's going to be trend going up until fourth quarter probably reach the 200 megawatts... that will be between approximately 5% or 10% range that would be approximately an estimate and, again, in the future and when we build products or the pipeline in the project, so that revenue will increase dramatically. [Terry Wang Q3 CC]

And right at the end of last year Trina signed another agreement for building an 1GW capacity power plant in China, which is a big deal:

The project itself will eventually represent 12.5% of Trina's annual manufacturing capacity, according to the Quartz report, which says business in China will also account for as much as 30% of Trina's revenue in 2013 - up from 13% in 2012. [CleanTechnica]

Trina Solar is set to expand its solar module manufacturing capacity by close to 500 megawatts (MW) by taking over the operations of NESL Solartech, a mid-sized Chinese module manufacturer, as it seeks to capitalize on the soaring global demand for photovoltaic products. [PV Tech]

Buy the shares?
Analysts, on average, expect 45 cent profit for 2014 and these estimates have gone up considerably in the last 3 months, but there is an enormous range from a loss of 49 cents to a profit of $1.89 between the 12 analyst, so we have some trouble believing if this figures are current.

Below is a figure with the earnings history and the consensus forecast.

For valuation, this matters rather a lot, needless to say. At a 2014 EPS of $1.89, the shares still have considerable upside, but not at the lower end of these estimates. You can wait for Q4 figures and guidance for next year from the company to emerge and feel more secure, but we're fairly sure we'll be at the higher end.

For starters, we already mentioned that some of these analyst estimates are likely to be old. See how they increased here. Ninety days ago, the consensus forecast was break-even for 2014, now it's 51 cents a share.

We also cannot see where the loss for 2014 that some analysts seem to predict would come from unless the market is to turn dramatically yet again, but there are really no signs of that. See in the graph below how the gap between supply and demand is tightening further in 2014:

World capacity is supposed to reduce from 51.1GW to 47.4GW, while demand strengthens from 35.3GW to 40.7GW. That's a 9.1GW tightening, or almost a quarter of 2014 demand. Difficult to imagine that ASP's would fall in such a tightening market.

Of course these are estimates, but what we hear in guidance from solar companies, they expect ASP to stay stable or even rise a little. With a stable ASP and solid market growth, it's difficult to imagine a loss for a solar supplier so well positioned in the most important growth markets as Trina.

We therefore think that if you accumulate the shares on any pullback, you will do well in 2014.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TSL, over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.