Valuations for Chinese Solar Companies May Be Unsustainably Low

| About: China Sunergy (CSUN)

Market observers have always noted the pendulum can swing to extremes in both directions. That may be an understatement when comparing technology stocks which commanded price to earnings ratios (PE) in the hundreds a dozen years ago, and U.S.-listed Chinese solar companies today. Earlier Monday, China Sunergy (CSUN) dropped to $1.10 per share which compares to its $1.21 in earnings per share (EPS). In other words, China Sunergy dropped below 1x trailing earnings.

While China Sunergy is far from a perfect company, it is also questionable if it deserves current valuations. Granted its trailing earnings mean little when earnings are most definitely slated to drop this year. Even so, Wall Street still expects the company to be profitable in 2011. After all, even if China Sunergy’s profits dropped by 80%, it would still only trade at 5x this year’s earnings. On an intrinsic level, China Sunergy currently trades at less than a quarter of its book value.

China Sunergy is not without issues, however, as noted in previous articles. Although from a cost standpoint, the company is better positioned than many others outside of China in the solar industry, its sales channel is still not as strong as top tier producers such as Trina Solar (TSL), Suntech Power (STP), and Yingli Green Energy (YGE). In other words, its sales forecast is not secure as its higher tier peers. Although the company did warn on its second quarter, China Sunergy's cost structure is still competitive enough to generate profits once costs normalize to current spot market pricing spreads. As long as China Sunergy can maintain lowered 2011 shipment forecast of 580-600MW, earnings this year should still be around a third of 2010 levels. While a 60-70% decline in annual net income may sound dramatic, so is a PE of 1.

The company did announce good news lately when the Court of Appeal in Norway ruled in its favor. China Synergy’s $50m legal struggle with REC had been an overhang for almost two years, but with this favorable ruling, $50m of restricted cash on the company’s balance sheet should move to a free cash position. Based on its first quarter earnings report, cash and restricted cash totals were slightly over $160m. As long as China Sunergy’s large $156m accounts receivable balance is indeed insured as the company has stated in prior earnings conference calls, its liquid assets are still higher than its total corporate debt of $284m.

To be sure, China Sunergy carries much higher risk than most other U.S.-listed Chinese solar companies. Relatively speaking, 1 PE may still not be as attractive as a 3-4 PE for much stronger peers with less risk uncertainty. Still, current valuations appear as irrational on opposite extremes as technology and internet stocks during the y2k bubble. Unless those technology and internet companies grew at astronomical rates, valuations in the hundreds of PE back then were unsustainable.

As it turned out, a handful of companies indeed grew into those valuations but the vast majority collapsed and faded away. On the opposite spectrum, China Sunergy’s current valuations practically imply the company will fail to exist. While risks are higher at China Sunergy, based on all the information present today it is unlikely the company is at risk of failing. Current valuations for both China Sunergy as well as other U.S.-listed Chinese solar peers may be unsustainably low.

If nothing else, these two examples illustrate perfectly how far investor sentiment can swing in such a short period of time. Will the pendulum reverse to the opposite extreme in the next dozen years? Only time will tell. But one aspect of the stock market will never change: Regardless of how investors value stocks at any given point in time, stocks are still shares of companies where actual businesses are unlikely to endure as dramatic swings.

Disclosure: I am long TSL, YGE.

Additional disclosure: No position in CSUN, STP.