Jinko Solar Likely To End Fiscal 2011 In The Black

Feb.29.12 | About: JinkoSolar Holding (JKS)

Although Jinko Solar (NYSE:JKS) operates as a fully integrated crystalline module manufacturer, much like larger counterparts Trina Solar (NYSE:TSL) and Yingli Green Energy (NYSE:YGE), it differs in scale and cost structure. This differentiation has allowed Jinko to respond more nimbly in the rapidly changing solar industry environment during 2011. As a result, the company has been able to minimize inevitable losses on an absolute primarily caused by the rapid decline of average selling prices("asp") for solar products. Unlike many peers, which posted large fiscal 2011 losses or, in more extreme cases, shut down operations entirely, Jinko Solar is likely to post a rare US GAAP fiscal profit during 2011.

Jinko was far from problem free during 2011. An environmental issue at its main manufacturing plant caused a public relations nightmare which the company has aggressively tried to correct. Rapid declines in ASPs across all crystalline verticals caused JKS to write down roughly $31m of inventory while changes in financial conditions of its key European customers forced the company to take accounts receivable provisions totaling $18.3m. Nevertheless as a newer entrant among solar module suppliers, Jinko's operating cost structure remained relatively low and its decision of procuring key materials at market pricing instead of through long term contracts has allowed the company to minimize its cost liabilities in a rapidly eroding pricing environment.

Given Jinko Solar's third quarter earnings preannouncement, portions of its third quarter results were not much of a surprise. Total revenues were $279.2m which were within the company's revised guidance of $270-280m. Total unit shipments of 257.7MW were higher than its revised guidance of 210-220MW although the upside surprise came from liquidation of silicon wafers and solar cells at negative margins.

What Jinko did not warn investors about were large charges the company took in the third quarter. Although an inventory provision was anticipated to some degree, JKS still should have notified investors of the $26.8m inventory write down taken in the third quarter. This write down along with dilutive wafer and cell sales brought consolidated gross margin to just 3.7% from 18.4% for its core in house produced solar modules. Per watt gross margin for the company's core business of solar module production was $0.22/watt, inline with my $0.22/watt estimate although both unit costs and module asps were slightly lower than anticipated. Excluding the inventory provision and dilutive non-core product sales, the $45.5m of approximate gross profit generated from Jinko's core module business would have been high enough for the company to post an operational profit in the third quarter.

Much like many other direct peers such as TSL and YGE, JKS also took an accounts receivable provision in the third quarter totaling $18.3m. As with the company's inventory provision, investors were not warned of this charge in its earnings preannouncement. While normalized operating expenses remained at a reasonably low level of $23m in the third quarter, total expenses increased to $41.3m due to this provision. As a result, JKS reported a $30.9m loss from operations. Excluding these non-cash charges and including interest expense, Jinko's adjusted operational profit was $6.4m which was slightly less than my $10m revised estimate. Other non-cash non-operational items of more accounting in nature inflated Jinko's Q3 US GAAP net income to $10.7m.

For the third quarter 2011, Jinko Solar also reported a number of non-operational items which distorted overall US GAAP results. Although a net foreign exchange loss of -$1.3m in the quarter was small on an absolute basis, the company should have posted a reasonably larger net gain had it kept its hedging strategy constant. In past quarters the company over hedged its currency risks and as a result suffered losses when key currencies, namely the euro, rose opposite of hedges. Had that hedging ratio remained constant, JKS would have recorded a sizeable gain under the euro's third quarter depreciation which I estimated could have approached $8m.

In addition and what will likely be a recurring theme, Jinko reported large non-cash adjustments to the change in fair value of its recently issued convertible bonds as well as capped call derivatives linked to these bonds. The net effect resulted in a $48.8m gain due to gains relating to the loss in current market value for its convertible notes offset by losses from capped calls purchased on them. In general, quarterly gains in the company's stock price should generate a loss and vice versa due to mark to market changes in fair value for these items. With Jinko's share price rising only 5% during the fourth quarter vs. an 81% decline in the third quarter, overall adjustments on this issue should be fairly muted but should result in a small loss for Q4.

For the fourth quarter, Jinko Solar guided module shipments to range between 180-210MW with revenues in a similar $180-210m range, implying module asps at or slightly below $1.00/watt. With other metrics identified in its Q3 earnings conference call, a fourth quarter earnings estimate has been compiled below. As usual, these estimates only reflect information stated or implied by the company and do not speculate outside of those ranges. While this estimate assumes a small non-operational net foreign exchange loss, other unannounced gains or charges have not been factored and thus generally represent Jinko Solar's operational earnings.

JKS Q4 Earnings Estimate:

Revenues: $210m
Shipments: 210MW module
Asps: $1.00/watt module
Module Unit Cost: $0.88/watt
Gross Profit: 210MW x $0.12/watt = $25m
Gross Margin: 11.9%
Operating Expenses: $25m
Net Interest Expense: $8m
Net Foreign Exchange Loss: $1m
Tax: $0m
Net Loss: -$9m
Diluted Share Count: 26.8m
EPS: -0.34

As witnessed with recent preannouncements by Suntech Power (NYSE:STP) and Yingli Green Energy, US GAAP figures may differ substantially due to non-operational charges. As noted above, Jinko should post a mark to market translation for the fair value changes in its convertible bonds and derivatives linked to it. Since this item is almost impossible to estimate, it has been left out of the estimates above. Directionally given Jinko's share appreciation in the fourth quarter, a small net loss should result.

Other potential charges include those similar in nature to ones taken by JKS in the third quarter. Jinko's third quarter inventory and bad debt provisions were fairly high in percentage terms relative to the company's inventory and accounts receivables respectively. Consequently any additional charges in the fourth quarter would likely be much smaller. Although the company gave no guidance on any potential charges, investors should be aware that such charges could repeat albeit to a lesser degree.

While investors should expect the worse given the solar industry's extremely challenging environment during 2011, there could be potential positives above Jinko's fourth quarter guidance. As price elasticity has shown in the past, dramatic declines in module asps have generated sharp increases in demand. Industry sources noted an extreme pick up in demand last December as installers rushed to complete projects before the new year's feed-in-tariff rate reductions in key solar markets.

Several direct peers to JKS, such as TSL, STP, Canadian Solar (NASDAQ:CSIQ), and JA Solar (NASDAQ:JASO) either reported or guided for much higher than expected unit shipments. Since Jinko Solar has been in damage control mode after its environmental public relations fiasco last September, any guidance given by the company may be even more conservative than usual. The company's flat to 10% sequential decline in fourth quarter shipments could result in a meaningful upside surprise.

In addition, Jinko's decline in market valuations may generate opportunities which may generate US GAAP profits. The company has been actively repurchasing shares under its $30m share repurchase program. While a lower share count would not benefit earnings should JKS report a fourth quarter US GAAP loss, a fourth quarter profit would not be impossible if charges were limited and shipments higher than previously guided.

Other peers, such as Renesola (NYSE:SOL), LDK Solar (NYSE:LDK), and Trina Solar, have already repurchased corporate debt that has been discounted by the market. Given Jinko's willingness to repurchase its own shares, which management identified as incorrectly valued by the market, additional debt repurchases may also take place. With the company's convertible bonds trading at a 40% or greater discount to par value, any convertible bond repurchases could result in significant US GAAP gains.

Regardless of whatever Jinko Solar reports for the fourth quarter, especially when so many factors could shift the final result on either side of break even, investors should focus on the company's competitive strengths. In terms of the ability to produce the most competitive solar modules, JKS is strongly positioned. Unencumbered by long term polysilicon contracts, Jinko has been able to reduce its silicon cost faster and beyond levels reported by larger Chinese module manufacturing peers.

The company's large scale and fully integrated manufacturing platform also yields among the lowest module processing costs within the industry. These qualities have allowed it to out maneuver most industry peers and likely generate a rare industry fiscal profit for 2011. As volumes reaccelerate after the industry's brutal consolidation period, these same factors may also help Jinko's profitability sooner and to a higher degree than other direct peers.

Disclosure: I am long JKS, TSL, YGE, LDK.

Additional disclosure: No position in STP, CSIQ, JASO, SOL.