Unlike LDK Solar (LDK), which was the last U.S.-listed Chinese solar company to report first quarter earnings earlier this week, Renesola (SOL) was the first in the same peer group to report its Q1 2011 earnings late in April. As noted in a review of LDK Solar’s Q1 earnings, the operating environment for the crystalline photovoltaic segment of the industry has changed dramatically in the nearly six week gap between the two company’s earnings reports. Starting in early May, spot market pricing in key verticals have dropped significantly. While LDK’s second quarter guidance already reflects changes in the market environment, Renesola’s Q2 guidance, made prior to the severe average selling price (“ASP”) declines witnessed in May, now appears too aggressive.
Much like LDK Solar, Renesola’s main vertical of operation is silicon wafer production. Through the month of May, spot market wafer pricing declined by approximately 25% as per weekly quotations by PVInsights. However, Renesola’s wafer ASP guidance for second quarter only calls for an 8% decline from .87/watt recorded in Q1 to an expected .80/watt for Q2. Prior to the severe price declines seen in May, Renesola’s guidance made in late April seemed reasonable. Wafer pricing was still very strong throughout the first quarter as Renesola’s wafer ASP only dropped from .88/watt to .87/watt quarter on quarter.
Even during all of April, spot market wafer pricing remained strong at around .82-.84/watt despite pricing at downstream solar cell and module verticals dropping by as much as 30% since the start of 2011. Since upstream verticals are so highly dependant on the ability of downstream verticals to price its products, the collapse in solar cell and module pricing made the correction in silicon wafer pricing inevitable. As a result, silicon wafer pricing at the spot market level declined to as low as .60/watt by the end of May.
During Renesola’s Q1 earnings conference call, the company stirred some controversy with analysts as it tried to defend its argument that the company’s wafer ASP would not fall below .70/watt in 2011. Renesola stated that volumes were sold out this year, with the majority of shipments already fixed at contracted prices. According to the company’s annual report, 785mw of the 1300mw expected 2011 wafer shipments were at fixed prices.
As a stand alone statement, Renesola's claim its silicon wafer pricing would maintain a minimum .70/watt price level in 2011 was reasonable. However, coupled with the company’s view that downstream module pricing would fall to 1.10-1.20/watt, it seemed out of touch with historical evidence. Even the most efficient companies which purchase silicon wafers in order to manufacture solar modules require .50-.55/watt in additional processing costs. Most companies which produce modules from purchased wafers require anywhere from .60-.70/watts in incremental processing costs. Thus, total module costs from purchased silicon wafers at a .70/watt price point would average well over 1.20/watt. In essence, Renesola believed it could hold clients to a contracted price even if at that price its customers might only break even or perhaps even lose money by purchasing and processing Renesola’s silicon wafers.
As industry history has already shown, no single vertical can stay immune to the pricing activity of neighboring verticals for any prolonged period. If solar cell or module ASPs dropped, upstream silicon wafer pricing would eventually have to decline. If upstream silicon wafer pricing could not decline past a price point producers cannot make money, downstream solar cell and module pricing would have to adjust accordingly. In short, reasonable levels of gross profit among the different verticals that make up the crystalline photovoltaic value chain must be shared equally. Any disparity was typically caused by short term supply and demand imbalances and simply wasn’t sustainable. Renesola’s argument was contrary to historical supply and demand dynamics already witnessed in the solar industry. In fact, the company already went through a period of rapid price declines after the credit crisis hit in late 2008 where it had to adjust contract terms with customers to more properly align with market conditions at the time.
The recent price declines for solar wafers, solar cells, and modules will put the company’s theory to the test. If Renesola can indeed force its customers to take contracted volumes at fixed prices which are currently well above spot market pricing, then its former guidance for the second quarter is safe from revision. If by accepting Renesola’s original pricing terms, silicon wafer purchasers end up losing more money, then as history has already shown, customers would simply walk away, leaving contract disputes up to arbitration.
LDK’s recent earnings report has already indicated not only was pricing vulnerable but also volumes as well. Based on the mid-point of LDK’s Q2 shipment guidance, the company is not operating at full capacity in the second quarter by as much as 10-15%. If customers cannot make money, they simply stop buying and shut down production. No company in any industry will manufacture for greater gross losses. In addition, weaker industry participants have resorted to inventory dumping as sales avenues narrowed.
As noted by Digitimes, many key solar cell producers in Taiwan have experienced sharp monthly declines in revenues for both April and May. E-Ton Solar, a Taiwanese solar cell producer, saw May revenues decline by almost 42% month on month on top of April’s staggering 58% monthly drop from March. Such dramatic shortfalls in business by reasonably large middle market suppliers resulted in inventory liquidation of both finished and unprocessed components, such as silicon wafers. The result was seen by spot market ASP declines where the wafer and cell verticals saw 25-30% price declines since the start of the second quarter.
In light of the recent market environment and in correlation with LDK’s recent outlook, I have to revise my prior estimate on Renesola’s Q2 earnings expectation. While the company could still hold prior fixed contracted pricing, historical evidence indicates this scenario to be unlikely. As a result, I have lowered my ASP assumptions for Renesola’s second quarter sales. Because pricing at all verticals have also dropped, the company should see some benefit as costs for polysilicon and solar cell procurement should be lower as well. Blending effects for both cost and sales should also help dampen the overall magnitude of the pricing declines seen so far in the second quarter. The net effect should result in margin compression and thus noticeably lower net income.
Renesola Q2 Earnings Estimate:
Wafer Shipments: 180mw at .72/watt = $130m
Module Shipments: 90mw at 1.55/watt = $139m
Wafer Tolling: 80mw at .40/watt = $32m
Total Shipments: 350mw
Wafer: 180mw at .56/watt = $101m
Module: 60mw at 1.10/watt = $66m, 30mw @ 1.33/watt = $40m
Wafer Tolling: 80mw at .25/watt = $20m
Total COGS: $227m
Gross Profit: $74m
Gross Margin: 24.6%
Operating Expenses: $26m
Net Interest Expense: $6.5m
Net Income: $34m
Diluted Share Count: 90m
Potential Foreign Exchange Loss: $7m
Potential Foreign Exchange EPS Impact: .08
As noted in my prior summary, the above estimates reflect operational earnings and exclude unannounced non-operational gains or losses. Net foreign exchange impact has been estimated separately and reflect exchange rates as of today’s date (June 12, 2011). With three weeks of currency trading left in the quarter, the ultimate net foreign exchange impact has yet to be determined. In general, as of its last quarter, Renesola was over-hedged against the euro. As such, net foreign exchange losses would be recognized if the euro appreciated vs. the usd and the rmb, and vice versa.
Despite second quarter ASP weakness, recent developments in demand brought about by lower pricing could result in upside to Renesola’s module shipments. The company called for flat sequential module shipments in the second quarter, but a dramatic demand pickup in June as noted by several peers could cause Renesola’s actual module shipments to increase up to its 150mw quarterly capacity. Since module shipments bring in the highest per watt revenues, an upside surprise could dramatically increase Renesola’s overall Q2 revenues at gross margin in a respectable mid to high teens percentage.
Lastly, much of the recent negative near term news flow may already be factored into many U.S.-listed Chinese solar companies including Renesola. After all, Renesola is currently trading at just 2.5 times trailing annual earnings. However, it should be noted Renesola is still primarily a wafer producer with limited cell and module capacity with no current plans of higher integrated capacity for the remainder of 2011. Much of the company’s capacity outside of its wafer vertical is already close or at full utilization. As a result, Renesola can only make up for per watt gross margin contraction in its main wafer vertical with sheer higher volume. Whereas other peers more committed to integrated expansion would have more avenues to make up for per watt gross profit lost in any single vertical. Thus, it appears likely Renesola’s 2011 earnings per share (“EPS”) would decline over 2010 levels whereas most higher integrated peers would still be likely to post annual EPS growth based on current market conditions.
Disclosure: I am long LDK.
Additional disclosure: No Position in SOL, E-Ton Solar (Taiwan).