Although Suntech Power’s (NYSE: STP) operating performance during 2010 was extremely lackluster relative to peers and the industry as a whole, the company was still able to maintain its leadership position within the industry. In 2010, STP led the industry with 1572mw of solar products shipped, representing 124.5% volume growth over 2009. However, net losses excluding gains from affiliates totaled $12.9m in 2010, reversing a $89m profit posted in the prior year. Suntech’s 2010 net loss was mostly attributed in charges related to equity write downs in its investment in Shunda as well as failed capital investments made in thin film. Nevertheless, STP’s commanding share in panel shipments was a testament to the strength of its brand and competitive positioning in the industry. Although less noticeable during 2010 when the market was undersupplied, bankability factors should play a critical role in determining 2011 winners in a market that is generally viewed as oversupplied.
In the fourth quarter of 2010, Suntech continued to mark progress in its evolution from a cell and module producer to a more integrated panel producer with upstream wafer capacity after its acquisition of Rietech late last year. In fact, Rietech contributed $24m of STP’s $85m quarterly net income (excluding affiliate gains due to equity revaluations). Earnings per share (“EPS”) using this core operating net income figure came in at .43, beating of my .36 estimate and well ahead of Wall Street consensus estimates of .29 in EPS.
At its core operational level, Suntech posted Q4 gross profits of $153m which were higher than my $142m estimate. The surprise was a result of much higher than expected sequential quarterly shipment growth which STP guided at around 10% but posted nearly a 20% sequential gain. Based on metrics derived from the company’s comments, Suntech’s fourth quarter shipments were an industry high at around 507mw. Gross margin however were inline with my estimates as the company recorded a quarterly gross margin of 16.2% vs. my 16.3% estimate.
Moving forward, Suntech should continue to post improvements in both gross profit and gross margin. Starting in 2011, STP’s newly acquired Rietech wafer capacity will be fully consolidated into the company’s results. Although Suntech should only produce about 30% of its wafers internally in the first quarter, the percentage should gradually increase to the company’s targeted 50% wafer integration level by the end of 2011. Combined with a stated 70% coverage in long term contracted silicon materials, STP should benefit from lower silicon procurement costs relative to peers this year. The fourth quarter of 2010 should most likely represent a trough in the company’s business, and gross margin should improve to levels above 20% in 2011.
Ultimately, the profitability of many solar companies in 2011 will be linked to its competitive positioning within the industry. It is apparent that the industry is over supplied and evidence is clearly displayed by the spot market pricing declines since the start of the year. Many companies are forced to lower prices in order to get its products placed. In some cases, the pricing spread between key verticals even suggest some companies may be liquidating inventory at losses. Companies who do business on the outer fringes of the industry appear to be in trouble.
Suntech argues, along with direct tier one peers such as Trina Solar (NYSE: TSL) and Yingli Green Energy (NYSE: YGE), branding and thus bankability will be the key differential among industry players. Because many solar projects require financing in the multi-million dollar range, bankability should insulate higher tier capacity from pricing declines more than lower tier suppliers. Larger more conservative banks and institutions may only finance brands where not only the durability of its products are assured, but also the durability of the company supplying them. In an oversupplied market, lower tier brands would thus have to lower pricing to a level where increased returns attract higher risk investors.
According to Suntech’s analyst day presentation, only 9.5gw of an estimated world’s 27gw capacity is bankable. STP includes itself in the bankable category. Another 10.2gw are classified as “low-cost bankable” which may include many low cost second tier producers in Asia. The remaining 7.3gw are pegged as simply “unbankable.” As a result, despite what appears to be overcapacity in the solar industry, the effective capacity is much lower and may even fall below global demand volumes. If this opinion of the industry is correct, 2011 may be a very bi-polar year for the industry where leading participants continue to gain market share at the expense of less competitive companies. At least since the credit crisis in late 2008, this argument has been proven correct as higher cost or less bankable producers have slowly been taken out of the market and forced to shut down their uncompetitive capacities.
Who you are and who you do business with are thus critical under this thesis. If Jinko Solar (NYSE: JKS), a relatively new entrant in the global panel market, is any indication of the importance of bankability and industry positioning, higher tier suppliers such as Suntech may be in even better shape. In its Q1 2011 earnings report, JKS not only announced strong sequential module shipment growth but also strong second quarter shipment guidance. In addition, Jinko’s guidance on average selling prices (“asp”) was not as dire as current spot market suggested. At least for Jinko who many regard as a second tier supplier at best, better positioned companies and brands can differentiate themselves from the destructive pricing trends currently indicated in the spot market. As among the industry’s top company and brand, it is likely STP will also be insulated to an extent from the recent pricing trends.
For the first quarter of 2011, Suntech only gave limited guidance. The company expects shipments to remain flat sequentially but gross margins should improve to 20%. An upward surprise in quarterly shipments would be difficult to produce during a seasonally weak quarter and in light of Suntech already operating at the upper limits of its capacity. However based on comments the company made regarding increased internal wafer production capacity as well as its silicon procurement situation, STP could surprise in terms of gross margin. As usual, my earnings estimates are confined within statements made by the company, either directly or indirectly using derived figures. Below is an estimate on Suntech’s first quarter 2011 earnings.
STP Q1 2011 Earnings Estimate:
- Revenues: $910m
- Shipments: 510mw
- Asps: $1.72/watt
- Unit Costs: 150mw x $1.16/watt = $174m, 360mw x $1.38/watt = $497m
- Core Module Gross Profit: $877m - ($174m + $497m = $671m) = $206m
- Consolidated Gross Profit: $201m
- Consolidated Gross Margin: 22.1%
- Operating Expenses: $63m
- Net Interest Expense: $31m
- Tax: $18m
- Net Income: $89m
- Diluted Share Count: 185m
- EPS: .48
- Potential Net Foreign Exchange Gain: $8m
- Potential Net Foreign Exchange EPS Impact: .04
While Suntech’s operational results are fairly easy to estimate, the company’s US GAAP net income may differ substantially. First, as noted in my prior article regarding the company’s near comical currency hedging mistakes throughout 2010, STP’s actual foreign exchange translation is really a guess. Assuming the company did not alter its currency exposure relative to its Q4 2011 earnings report, Suntech should post a minor gain as the euro appreciated vs. the usd during the first quarter. However as noted, STP adjusted its hedging in each and every quarter last year which resulted in losses in every quarter. If this past trend continues, it’s entirely possible the company posts an opposite result and net foreign exchange losses result for the first quarter.
In addition, the estimates above exclude any gains or losses from Suntech’s affiliate holdings as well as any other unannounced operational charges. Although many of STP’s legacy mistakes have already been written off in the past couple of years, it is still possible the company records additional losses or reversal of losses booked prior regarding its numerous equity investments. As usual, investors should concentrate on Suntech’s operational earnings in order to determine the true strength of the company’s core business of module sales.
As a final note, Suntech released its 2010 annual report after this article was originally written. A few revisions had to be made to the company's unaudited earnings announcement earlier in March of this year. Most notably, prior tax benefits of $2.5m were changed to tax expenses of $23.8m, or a $26.3m difference which restated prior 2010 net income of $13.4m to a net loss of $12.9m. Hence changes to this article have been made to reflect STP's recent SEC filings. In addition, the company also reclassifed several balance sheet items which resulted in an additional $0.9m gain in earnings from affiliates. Investors may wonder if these discrepancies along with Suntech's badly mishandled foreign currency hedging in 2010 caused the company's recent change chief financial officer several weeks ago.