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ReneSola (NYSE: SOL) recently released its first quarter 2011 earnings, which were more or less inline with expectations. Revenues declined sequentially to $328.2m from $386.4m posted in the prior quarter, but were still within the company’s guidance range of $310-330m. Total shipments also declined to 330.4mw from 349.4mw recorded in the fourth quarter of last year. Again, ReneSola’s shipments were well within the range of the company's 320-330mw guidance, as declines were mostly attributed to seasonal factors. Finally, gross margins came in at 30.7%, which were also within ReneSola's prior guidance range of 30-32%.

Earnings per share at the headline level did miss Wall Street consensus. ReneSola’s reported .49 in EPS for Q1 2011 which were below .58 per share estimated by analysts. ReneSola’s EPS miss was mostly due to a net $15m foreign exchange loss caused by forward currency hedging. Excluding this foreign exchange loss and the subsequent tax implications ($12.2m at the same tax rate), ReneSola would have posted an operational .62 EPS which is inline with my estimates of .62 in earnings per share. On a core operational level, excluding currency factors ($12.2m), ReneSola’s net income was $55.5m. This came in slightly above my $55m estimate, although I had cautioned ReneSola could post net foreign exchange losses up to $27m for the first quarter of 2011. It appears the company may have changed its forward hedging strategy slightly as the euro appreciated during the quarter, hence reducing its net exposure from the prior quarter.

I won’t review ReneSola’s business model in this article since I have discussed the company’s operations in detail in past articles. Instead I will review comments the company made looking forward and as usual post my earnings estimate for the current quarter.

ReneSola’s near term earnings peak should not be much of a surprise. With core wafer average selling prices ("asp") reaching a peak in the fourth quarter of 2010 and the company’s capacity reaching a near term ceiling, revenues were destined to decline until new capacity came online to make up for pricing declines. In fact, ReneSola had already spelled out average selling price declines for the entire year as the company expected its core wafer asps to be around .85/watt, .80/watt, .75/watt, and .70/watt for Q1 through Q4 of 2011, respectively. The company’s Q1 wafer asp actually came in higher than forecasted at .87/watt, signaling continued shortages in the wafer vertical relative to downstream verticals.

There seems to be a delay in the company’s new 600mw of wafer capacity coming online. In prior conference calls, ReneSola had signaled new capacity would be online for Q2 but has been pushed back until Q3 per its Q1 2011 conference call. As a result, ReneSola’s capacity would remain mostly unchanged for the entire first half of 2011. Without the ability to increase shipments, pricing declines would result in lower revenues and consequently lower levels of gross profits.

Other than operational issues, ReneSola also made rather startling comments on the industry overall. It remains in question why management would make such comments. Perhaps in part it was to paint a conservative picture amidst its own near term operational headwinds. Perhaps in part it was to explain ReneSola's view on the recent dramatic spot market declines across all verticals of the crystalline pv value chain. Whatever the reason, ReneSola’s comment on module average selling prices potentially dropping to 1.10-1.20/watt by the end of 2011 is truly worth discussing in greater detail.

What was ReneSola’s rationale for projecting module asps potentially dropping as low as 1.10-1.20/watt by the end of the year? According to management, large overcapacity in downstream cell and module verticals could drive asps much lower. To be sure, spot market asps on cells and modules have dropped significantly since the start of the year. For cells, spot market average selling prices have dropped from around 1.40/watt at the turn of the year to below 1.10/watt recently. For modules, spot market asps have dropped from around 1.75/watt at the end of last year to about 1.50/watt recently. Reportedly low end asps have gone below 1.00/watt for cells and below 1.40/watt for modules. However despite these asp declines, many major industry producers can still make money. As long as positive gross margins can be generated, asp declines, however large, could still be rationalized in an over-supplied market.

ReneSola’s management takes this logic to another level through linear extrapolation. In the company's Q1 2011 conference call, ReneSola justified its module asp prediction even as it kept its asp guidance on its own products.

Even wafer pricing around .70 cents, the cell and module processing costs are going to be well below .50 cents, so even at a 1.20, companies are still going to make a slight profit, and this is not that bad of an outcome against a very large overcapacity situation.

In other words, ReneSola’s management believes it can still keep its .70/watt Q4 2011 wafer asp guidance, which would generate over 20% gross margins based on the company's prior operational efficiency statements. This despite most, if not all, of its wafer-consuming customers operating at a break even or even negative gross margins. As most industry veterans now know from past cycles, ReneSola’s expectations are simply unrealistic.

First, no company would continue to operate at negative gross margins. Uncompetitive capacity would simply shut down rather than lose even more money by having the lights on. This was already clearly evident in the solar industry with higher cost peers shutting down operations where market pricing penetrated below their production costs. It may be possible for companies to sell at negative margins for liquidation purposes, but such activity cannot be sustained beyond over-supplied inventory levels.

Secondly, no single vertical has been a bulletproof island of safety. If one vertical was experiencing pricing pressure, everyone else (especially upstream) would also experience pricing pressure sooner or later. Only for short two or three quarter periods did any single vertical experience disproportionate pricing advantages over peer verticals. Recently, shortages have been more pronounced at the upstream wafer vertical, but if downstream verticals get squeezed to break even levels, pricing would have to eventually normalize such that all verticals share a rational level of gross profit based on their capital costs.

Lastly, ReneSola makes the same mistake most industry pundits in the past have made regarding overcapacity. ReneSola’s management entirely discounts price elasticity as well as the fact not all capacity are created equal. Within the industry’s cumulative capacity, production costs can range widely. Just within the crystalline pv space, production costs ranged from near 1.10/watt to over 2.00/watt seen last year. Just as a crude example, there may be 25gw of capacity and only 20gw of demand, but if 7gw of that capacity could not offer competitive pricing, then the overall market would still be undersupplied.

One extreme example of this flawed “overcapacity” logic can be seen in an article released in late 2009. The article predicted the massive inventory glut and overcapacity would cause average selling prices to fall below 1.00/watt in 2010 and potentially reach .50/watt in 2011. Well, not quite: Module asps, even for the lowest cost tier one providers such as Trina Solar (NYSE: TSL), Suntech Power (NYSE: STP) and Yingli Green Energy (NYSE: YGE) averaged over 1.70/watt in 2010 and well above 1.50/watt currently.

While many arguments made by similar pundits sound quite informed and reasonable, it should be quite clear most “experts” who try to follow the solar industry think from a linear one dimensional academic standpoint rather than from a realistic, practical business standpoint. To be fair, because many solar companies are also stocks listed on national markets, opinions may be biased as to present a trading opinion rather than to provide a realistic and objective prospectus on actual businesses within the industry.

Luckily solar analysts today are much more in tune with realistic industry dynamics than their notorious predecessors a few years ago, who often badly misjudged companies as well as the overall industry. In fact for a good portion of ReneSola’s Q1 2011 conference call, analysts continued to debate management to verify if they truly believed such low asp end points were realistic. Many of the points listed above were brought up in the conference call debate, and despite several counter arguments, ReneSola’s management continued to defend its belief that such average selling prices could be realized by the end of 2011. Quite frankly, Auriga’s Mark Bachman’s final comment best summarized the entire debate.

I would say, I would argue with you there that you can quote all the capacity numbers you want but it's not cost effective capacity out there. I have to say I find your comments here quite reckless and I hope you didn't kill the solar market here today.

In an industry already suffering from numerous misconceptions, ReneSola’s comments are unnecessary and out of line. The company already suffers from misguided comments made in past conference calls regarding metrics that should already be known about its own business. For example, management inaccurately guided its inventory costs in 2009, which caused several quarters of earnings misses in the same year.

In conference calls made last year, the company also stated that a good portion of 2011 polysilicon procurement was secured at fixed prices below $50/kg. Yet, despite producing at near capacity at its polysilicon plant in Q1 2011, at costs between $40-45/kg, blended polysilicon costs were $60/kg. This suggests external procurement costs were well above $60/kg.

On a similar note, ReneSola also stated in its Q3 2010 conference call that internal polysilicon production costs were below $50/kg, with only a month left in the fourth quarter. When actual Q4 2011 earnings were released, internal polysilicon production costs were listed at $55-60/kg. Either production costs averaged below $50/kg during the first two months and in the final month of the quarter costs soared above $70-80/kg in order to reach their $55-60/kg blended average, or management had no accurate grip on its production costs on already produced products.

At the very least, comments made during ReneSola’s conference calls should be taken with a grain of salt and a heavy dose of due diligence. Continued misguided statements made during ReneSola’s conference calls should make investors question whether management has an accurate account on the overall industry, let alone its own business.

With main metrics regarding ReneSola’s business at relatively stable levels, estimating the forward earnings for its second quarter is a little easier than debating management’s viewpoints many quarters out. As noted, the company should suffer from capacity constraints and thus shipments should remain within the same range seen in the prior couple of quarters. With average selling prices declining, the company should report lower gross profits. As usual, my estimates are within the range of the guidance given by the company and do not speculate beyond such guidance unless certain metrics cannot be verified with past results. ReneSola’s official guidance for the second quarter is as follows: Shipments 330-350mw, revenues $280-300m, and gross margins 25-27%.

ReneSola Q2 2011 Earnings Estimates:

  • Revenues: $318.7m

  • Wafer Shipments: 180mw at .80/watt = $144m

  • Module Shipments: 90mw at 1.55/watt = $139.5m

  • Wafer Tolling: 80mw at .44/watt = $35.2m

  • Total Shipments: 350mw

Unit Cost:

  • Wafer: 180mw at .58/watt = $104.4m

  • Module: 60mw at 1.10/watt = $66m, 30mw @ 1.4/watt = $42m

  • Wafer Tolling: 80mw at .24/watt = $19.2m

  • Total COGS: $231.6m

Balance sheet:

  • Gross Profit: $87.1m

  • Gross Margin: 27.3%

  • Operating Expenses: $26m

  • Net Interest Expense: $6.5m

  • Tax: $10.4m

  • Net Income: $44.2m

  • Diluted Share Count: 90m

  • EPS: .49

  • Potential Foreign Exchange Loss: $10m

  • Potential Foreign Exchange EPS Impact: .11

The .49 EPS estimate given above represents operational earnings excluding currency translations as well as any other unannounced one time items. The foreign exchange loss of $10m estimated above represent estimated losses at 1.48 usd to euro exchange rates seen today. With two months left in the quarter, actual currency gains or losses remain a moving target. Finally, diluted share count could also increase if ReneSola’s stock closes above $10.55 for an extended period since it represents the conversion and hence dilution level for the company's recent convertible bond offering.

Disclosure: I am long TSL, YGE.

Additional disclosure: No position in SOL, STP.

Source: A Closer Look at Renesola's Q1 2011 Earnings and Controversial Statements