Among all the solar component manufacturers, manufacturers of the silicon wafer or the upstream components of the vertical had the lowest net profit in the year 2013. This is contrary to the solar cell and module manufacturers, where the manufacturers could generate a decent margin.
This is going to change in 2014. The supply of wafers has been limited in 2014 so far, and will remain this way for the rest of the year due to the increasing demand by solar manufacturers. The demand is projected to be 50 GW for 2014, while the projected supply is about 45 GW.
An interesting observation can be made if you analyze ReneSola's income statements from 2010-2013. We can see a time lag when ReneSola started losing money in comparison to downstream manufacturers. Furthermore, ReneSola did not turn a net profit in 2013, while some of the downstream manufacturers did exceptionally well.
The prices of wafers have lagged in terms of recovery when compared to the rest of solar components. Upstream heavy companies such as ReneSola generally have a delay in profit improvement when recovering from a situation of oversupply, compared to the downstream manufacturers of modules and solar cells.
The infrastructure to build capacity in polysilicon and wafers is time and capital-intensive. This is responsible for the lag in time between starting to lose money and subsequently returning to profit in terms of oversupply and the subsequent rebalancing of the supply. All of this creates liability and uncertainty, as we have seen in the last few years.
The fourth quarter of 2013 was the tipping point for the upstream manufacturers. The balance is shifting in favor of upstream manufacturers in 2014. This will result in a reduction in the margins of downstream solar companies JinkoSolar (NYSE:JKS), Trina Solar (NYSE:TSL), Canadian Solar (NASDAQ:CSIQ), Yingli Green Energy (NYSE:YGE).
Transition At ReneSola While The Balance Is Tipping
ReneSola still remains a dominant upstream player. However, it is in transition and has used time and capital extremely wisely during 2011-2012, and has increased its revenue using its OEM strategy. My estimate is that about 2/3rd of the revenue in 2014 (estimated at $2 billion) will be OEM revenue. The gross margin, based on my own estimates, will be at least 14% of this revenue. This means that $186 million of gross margins with minimal fixed costs and liabilities will be attributable to this source of revenue. This is a shift from the past, when revenue was mostly from upstream manufacturing.
The transition in ReneSola's business over the last two quarters has been misunderstood by investors as a laggard in terms of gross and net margins. ReneSola has been investing in expanding its OEM capacity and sales network. The company has taken a conscious decision not to expand its manufacturing capacity. ReneSola is moving away from being a solar manufacturing company to becoming a global seller and contract manufacturer. In 2014 itself, the company will have a large variety of products besides solar modules, including inverters, LED lights, and energy storage business. This is likely to contribute to the revenue and gross margin in 2014.
This business model is similar to the large US corporations that have manufacturing partners around the world. The OEM strategy gives it a lot of flexibility in terms of OPEX structure and helps it deal with various trade restrictions on solar products across major markets.
All of this means that it should show significantly "stable" margins when compared to its peers in downstream or upstream solar manufacturing.
While other "Chinese solar" companies are predominantly manufacturing companies that are selling solar commodities, ReneSola has focused on building its sales and OEM network.
The OEM strategy at ReneSola is different from its peers. ReneSola is creating regional moats, partnering with major producers in selected geographical areas. ReneSola adds the brand premium to the cost of the products supplied by these OEMs, and sells the products in various markets. This provides ReneSola with an opportunity to significantly decrease its liability over next few quarters. This also gives ReneSola stability, and essentially eliminates the risks associated with the boom and bust cycles related to the solar business.
Peers such as Trina Solar, Yingli Green Energy, and JinkoSolar will ship slightly more modules than ReneSola. However, their fixed costs are significantly higher than ReneSola's. For example, ReneSola employs about 8500 workers. This is about half the number of workers per MW of modules shipped for any other tier-one Chinese solar company.
Investors are not capturing all of this transition, and they are evaluating the company by comparing the gross and net margins to other Chinese solar companies. Margins will improve once the OEM partnerships mature and the learning curve is over.
Investors are ignoring the fact that ReneSola has been paying off its debt, and it has stated in the press that it will be selling its power plant business and reduce liability quarter over quarter. My estimate is that it will reduce its debt from around $900 million to about $600 million by the end of 2014.
The market has also ignored the fact that the historical problems that have affected ReneSola's profitability have been proactively tackled by the management. It closed its Phase I polysilicon plant a few months ago that was a loss-making venture for ReneSola. The company is shifting from a low-margin business of manufacturing wafers to a higher-margin business of selling modules.
ReneSola is at the edge of profitability and it will return to profitability in 2014. All the while, it is working on transforming itself to become a typical American company, with manufacturing being outsourced to other partners.
Outlook For Solar Industry In 2014
In spite of various reports about decreasing the cost of solar module production, I do not see much more decrease in cost/wattage. The slight improvement being projected is mostly due to an increase in efficiency: 50 cents per watt appears to be the floor for the next few years. Blended ASPs across all the geographical locations are likely to be between 68-70 cents per watt for 2014.
The demand for 2014 will be about 50 GW, and supply is going to be tight, with tier-one production reaching around 45 GW. I do not see manufacturers ready to ship 50 GW of marketable modules at this time. Therefore, we can presume that deployment in 2014 will be strongly production-controlled.
If European demand picks up by the end of this year, dynamics may tilt further in favor of the solar industry. Italy seems to be the predictor for the rest of Europe. If the demand in Italy exceeds 2 GW in 2014, we can presume that Germany and France will follow.
CIGS will be the technology to watch out for over the next few years.
Earnings Estimates For 2014
Polysilicon spot market prices will range around $20-25/kg for 2014. Cost of polysilicon per watt for ReneSola will be roughly $0.13/watt. My estimates are that real wafer cost is about $0.23/watt, or $0.98/piece.
The inventory liquidations are finished, and market price for wafers is likely to return to $1.10 per wafer.
ReneSola has a total capacity of 3.1 GW/year, and it projects 500 MW of module sales for Q4 2013. This is inclusive of its OEM capacity.
If we extrapolate that to next year's sales and add some growth, we get about 2500 MW in module sales (all OEM growth, without investment into any cell capacity) and 600 MW of wafers.
Recent ITC decision to investigate dumping charges will tick the module prices upwards, and ReneSola has an edge to bypass the tariffs due to its OEM strategy. My take on this is that there will be about 10% tariff on Taiwanese cells. This will increase the ASPs in USA to $0.75/watt.
Average selling prices in USA and Japan are higher than rest of the world. ReneSola has increased the % of shipments to USA and Japan quarter-over-quarter for the last 3 quarters.
Estimated internal cost of module for ReneSola is $0.53/watt. OEMs will sell to ReneSola for $0.58/watt. Blended cost is going to be $0.57/watt. (1200 x .53 + 1300x .58)/2500 gives you the blended cost.
I have assigned expected ASP of $0.68/watt for 2014, it is higher than the current ASP because of multiple bullish reasons for ReneSola and the industry discussed above.
Modules gross margin per watt = $0.11, hence, 2500 MW x .11 = $275 million. Rest of the capacity will be sold as wafers. 135 million (pieces of wafers from 600 W capacity) x $0.12 = $16.2 million. 6500 MT of polysilicon will save the company $5/kg, or $32.5 million. If we increase the module shipments to 27500 MW, we can achieve $345 million in gross profit.
Also, ReneSola has been working hard on decreasing its fixed expenses that will add to the net profits. Sale of inverters, LED lights will add another $100 million in revenue and some gross profit to the equation.
We get a gross profit of $321 million. If, for some reason, polysilicon production takes some time to stabilize, we may only realize $16 million in savings from polysilicon. So, I will round off our gross margin to $300 million. OPEX and interest will take away $230 million of the gross margin. We get $70 million net profit.
This will mean $0.70 profit per ADR. If we give it a P/E of 10, we will get a target price of about $7.
I have not put any premium that may be warranted for being an asset-light business with ongoing significant reduction in debt. This could add another $5 to the share price.
ReneSola is pursuing a strategy different from other Chinese solar companies. If this strategy proves to be wrong, ReneSola may lose ground to other solar companies. Also, ReneSola has not turned profitable as of yet, and all the calculations of profit are estimates based on good execution of the current strategy.
Disclosure: I am long SOL.
Business relationship disclosure: Bravo Family Fund is a team of Individual Investors. This article was written by Roli Agrawal, one of the members of the group. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.