With the photovoltaic solar industry undergoing a destructive consolidation period, more and more companies have found themselves on the losing side. Dramatic declines in solar module average selling prices("ASP") have forced numerous manufacturers to curtail or even shut down operations completely as market pricing fell below production costs. While corporate failures have been more public among "western" companies, dozens of lesser known small scale Chinese producers have also fallen victim to the industry's harsh pricing environment.
China Sunergy (NASDAQ:CSUN) was among the first batch of Chinese solar companies to be listed in the US and during its initial 2007 IPO period was also among the larger global solar cell suppliers. Despite early advantages, CSUN has fallen behind many peers to the point its status as a longer term survivor may be in jeopardy.
As noted in my prior China Sunergy related articles, the company has had an unstable earnings track record. In part this was due to the company's reliance on a single vertical solar cell business. With a greater proportion of the value chain beyond the company's control, CSUN's profits were simply a function of market forces. As a result, the company's only profitable fiscal year since becoming a public company occurred in 2010 when global demand far exceeded manufacturing capacity.
Secondly, China Sunergy's costs were never in line with many peers despites many more years of operating experience as well as a self proclaimed technological advantage. CSUN's solar cell processing costs typically ranged 10-20% higher than direct peers. With per watt gross profit still relatively high prior to 2011, less efficient companies could still operate profitably. 2011's dramatic collapse in module asps have brought absolute per watt gross profit for the entire value chain to a bare minimum where only large scale, highly integrated, and cost efficient manufacturers could turn a profit.
With each earnings report, China Sunergy is moving itself more and more into the questionable category. Similar to most industry peers, CSUN lost money in the third quarter of 2011. Although overall quarterly shipments were the highest in the company's history at 116.2MW, it was still well below the 140-160MW guidance previously given. While large US listed peers such as Trina Sola (NYSE:TSL) and Yingli Green Energy (NYSE:YGE) also missed 2011 shipment targets by 14% and 6% respectively, China Sunergy's revised 2011 annual shipments target of 395-405MW falls significantly below its original 670-690MW range. As noted in a prior CSUN article, China Sunergy's lower tier status placed its shipments and market position at a higher risk.
On a US GAAP basis, China Sunergy lost $31.3m or -0.78 in earnings per share ("EPS") in the third quarter of 2011. Similar to TSL and YGE, CSUN also took an inventory provision in the quarter. Unlike larger peers, the company's $26.8m inventory charge was disproportionately high relative to its $98.9m inventory level at the end of the prior quarter. Although this write down contributed to the bulk of its third quarter losses, it should help fourth quarter margins. According to CSUN's Q3 earnings conference call, module inventory was written down to just $0.89/watt vs. an expected fourth quarter asp level of $0.91/watt which in theory should yield a small gross profit.
What is most concerning about China Sunergy is its expected fourth quarter cost structure and gross margin expectation. Instead of guiding for slightly positive gross margin, management guided for zero margins due to higher quarterly production costs despite inventory levels already written down below market pricing. Based on metrics given in its conference call, Q4 module production cost is estimated around $0.98-0.99/watt largely due to underutilization. Only through a guise of its large third quarter inventory write down would the company be able to post zero gross margin. Like many higher cost peers that have already folded operations as market pricing fell below internal production costs, China Sunergy's future profitability and thus survivability have become increasingly in question.
China Sunergy's management has provided potential production cost targets which in theory should yield positive levels of gross profit. However, as I have cautioned in prior articles, what CSUN has guided in the past and what was actually reported have often been very inconsistent. The company has had a very poor execution track record as a public company given the majority of its quarterly reports have often been in the loss category.
With solar module ASPs reaching an absolute low threshold where only the most efficient manufacturers remain profitable, cost structures have become the key metric in separating the winners from the losers as the industry consolidates. If China Sunergy can not turn theoretical metrics into operational results quickly, its own survival may be in jeopardy given poor execution in the past have already increase leverage on the company's balance sheet to fairly high levels.
For the fourth quarter of 2011, China Sunergy guided shipments to range between 95-110MW and gross margin to be around the zero percent level. Although Q4's gross margin appear to be aggressive given metrics its management stated during its quarterly conference call, an earnings estimate using mid-point levels reflective of the company's guidance has been compiled. As with all my estimates, the accuracy merely reflect the accuracy of the company's guidance and exclude potential unannounced non-operational gains or charges.
CSUN Q4 Earnings Estimate:
Shipments: 102mw module @ $0.91/watt
Blended Unit Cost: $0.91/watt
Gross Profit: $0m
Gross Margin: 0%
Operating Costs: $15m
Net Interest Expense: $7m
Net Foreign Exchange Loss: $1m
Tax Benefit: $2m
Net Loss: -$21m
Diluted Share Count: 40.1m
As noted above, if fourth quarter production costs are at a high level, it is questionable CSUN can even maintain flat gross margin. The counter balancing upside may be the company's extremely low module ASP assumption. Nevertheless, any potential upside on the asp front would likely be negated by the company's high unit production cost. In any case, China Sunergy should post an operational loss for the fourth quarter generally outlined by the estimate above.
Although the company settled a legal dispute with REC over a $50m prepayment in its favor, additional legal expenses may be incurred in the quarter as a result. In addition and similar to other direct peers such as TSL and YGE, CSUN may take additional charges such as bad debt provisions in the final quarter of its fiscal year. Lastly, a potential non-operational upside could result if the company continued to repurchase its convertible bonds at a discount to par value. An approximate $7m gain was booked in the third quarter from such convertible bond repurchases.
For the foreseeable future, given China Sunergy's cost structure, it would be unlikely any quarterly profits could be attained given the industry's operating dynamics. In an attempt to boost investor confidence, management noted CSUN's Chairman bought 5% of the company's shares in the open market. Still, the company's relative debt and cash flow levels should be a caution flag for investors.
While in the near term local banks may likely continue supporting the company, continued losses could eventually cause lenders to reconsider. Contrary to perceptions view by observers in the United States, Chinese lenders have not subsidized its solar companies with cheap and unlimited lines of credit. Chinese banks do and have cut the cord on a number of failed domestic solar companies.
Perhaps the most publicized was Shunda's collapse which caused Suntech Power (NYSE:STP) to write off almost $200m of investment losses. While debt levels among other Chinese solar peers may also be at similarly high levels, larger direct peers such as TSL, YGE, and STP have already proven a cost structure low enough to maintain operational profitability in the future. Until China Sunergy actually delivers on its lower manufacturing cost targets, solar weary investors should remain cautious on the company.
Additional disclosure: No position in CSUN, STP.