Trina Solar Closes Out 2011 With A Q4 Shipment Surprise

| About: Trina Solar (TSL)

Similar to most solar companies, Trina Solar (TSL) ended the final quarter of 2011 with additional losses. While Q4 2011 losses were expected, there were some upside surprises in its quarterly earnings report. As the industry's ongoing consolidation continued dragging module average selling prices("asp") lower, elasticity as shown in the past generated a significant demand surge in the final months of 2011. As one of the industry's leaders, TSL also experienced a sharp surprise in demand evident in its fourth quarter shipment surprise of 425MW vs. an original guidance of 320-350MW.

Trina Solar's Q4 shipment surprise lifted its annual shipment totals to 1.51GW. While the company's annual shipments grew 43% year over year, it still fell short of the its initial 1.75-1.80GW target and lagged the industry's overall installation growth rate of approximately 59%. Despite losing slight market share in 2011, Trina still increased its industry ranking a notch by becoming the industry's fourth leading module supplier from a fifth place ranking in 2010 with only Suntech Power (STP) and Yingli Green Energy (YGE) ranked higher among direct peers. In general, 2011 was a year which saw higher cost structured manufacturers losing market share as the industry was flooded by supply from newer lower tier companies. Unwilling to match pricing levels that reflected inventory liquidation by distressed peers, most top tier suppliers like Trina missed original 2011 annual shipment targets.

The upside surprise in Trina's fourth quarter shipments did come at a cost and perhaps represented the company's own year end inventory close outs. With inventory levels increasing throughout the first three quarters of 2011 to abnormally high levels relative to the company's historical averages, Trina likely liquidated portions of its inventory into the industry's surprise demand surge in Q4. After increasing to $335m in Q3 2011 from just $79m at the start of last year, TSL's Q4 inventory levels decreased sequentially to $250m. The 27% upside in Q4 shipments and better inventory control came at the price of much lower than previously guided module asps. On average, Trina's Q4 asps were $1.01/watt, much lower than a range around $1.10/watt indicated in its Q3 earnings conference call but still higher than the industry's spot market levels of $0.90-0.95/watt in the same period.

As a result of lower than expected module asps, the company's gross margin also missed its original guidance. Fourth quarter gross margin was 7.1% vs. a range of 10% guided in its third quarter earnings report. Excluding a $3.3m provision TSL took to account for a potential retroactive 8% tariff for products shipped to the US, adjusted gross margin would have been 7.9%. Blended gross margin would have been much lower had the company not been able to reduce its module production cost to a lower than expected level. Trina's average module unit cost for the quarter was $0.94/watt, slightly lower than my $0.98/watt estimate which was based on metrics provided by the company.

Although other factors including TSL's continued reduction of module conversion costs to $0.63/watt contributed to lower realized unit costs, the bulk of the reduction most likely came from lower polysilicon procurement costs. Once Trina Solar's blended inventory costs become normalized to real time procurement levels, the company's module production cost could trend towards $0.70-$0.75/watt which would be on par with First Solar's (FSLR) $0.73/watt module unit cost reported in its latest earnings report. The collapse in polysilicon pricing from under supplied levels which handicapped crystalline photovoltaic manufacturers like Trina Solar in the past has neutralized cost advantages once held by competing technologies such as FSLR and other thin film manufacturers.

Despite Trina Solar's structural cost advantages, the industry's ongoing consolidation cycle has put pressure on all solar manufacturers. Pricing spreads among the crystalline segment has become so distorted due to continued industry shut downs and liquidations that even the most competitive companies cannot maintain corporate profitability. For the fourth quarter, Trina reported a gross profit of $31m which is far below the company's corporate expense run rate of approximately $75m per quarter. Additional charges totaling $25.4m added to quarterly expenses. As a result, TSL reported a Q4 US GAAP net loss of $65.8m or 0.93 in earnings per share("EPS"). Excluding unannounced items, TSL's adjusted operating losses would have totaled $37.1m which was higher than my $31m loss estimate. As noted above, Trina's upside surprise in shipments was more than offset by much lower than previously guided module asps which in total generated a lower gross profit.

For 2011, Trina Solar posted a US GAAP loss of $37.8m or 0.54 in EPS vs. a profit of $311.5m in the prior year. It is interesting to note that excluding net foreign exchange losses of $38.8m in 2011, Trina would have posted a very small profit at an operating level despite a number of charges taken through the year. TSL's 2011 consolidated gross margin was also relatively robust at 16.2%. Unlike a large portion of the industry, Trina Solar did not sell below costs otherwise referred to as "dumping" and consistently sold at asps above market averages. While TSL's management still grossly mishandled annual guidance expectations, the company still exited 2011 in much better shape than the vast majority of its peers.

For the first quarter of 2012, seasonally the weakest quarter for the solar industry, Trina Solar offered fairly strong guidance. Total shipments are expected to range between 400-430MW which would represent a fairly flat quarter on a sequential basis. Overall gross margin is also expected to expand into the low teens percentages. Based on this guidance as well as other metrics indicated in its Q4 earnings conference call, an estimate for TSL's first quarter earnings has been compiled below. As usual with all my estimates, all unannounced gains or charges have been excluded and the estimates generally represent operating expectations in the company's core business.

TSL Q1 2012 Earnings Estimate:

Revenues: $393m
Shipments: 415MW
ASPs: $0.93/watt
Blended Unit Costs: $0.83/watt
Gross Profit: 415 x .10 = $41.5m + $1.5m system = $43m
Gross Margin: $43m / $393 = 10.9%
Operating Costs: $68m
Net Interest Expense: $9m
Net Foreign Exchange Gain: $2m
Tax Benefit: $3m
Net Loss: -$29m
Diluted Share Count: 70.5m
EPS: -0.41

Unlike the industry's past consolidation cycles, the current ongoing cycle appears to be an all out death struggle with a take no prisoners approach. Industry pricing in all segments of the value chain continue to be at unsustainable levels where market asps are at or even below production costs for many companies. Even for the industry's lowest cost suppliers like Trina Solar, pricing is at levels where the company cannot maintain corporate profitability. Although Trina's Q1 costs still reflect some higher cost legacy inventory, real time gross margin would still unlikely be high enough to generate a US GAAP net profit. Assuming only real time procurement costs, TSL's module unit cost in Q1 would likely be around $0.77-0.78/watt which would generate slightly less than $70m in gross profit while the company's operating expenses and interest costs should total slightly more than $75m. Although Trina Solar could survive many more quarters at this operating level, most higher cost structured peers probably could not maintain higher magnitudes of percentage losses indefinitely.

The clear losers have been higher cost structured "western" companies and to a lesser extent, Japanese brands which once dominated the photovoltaic industry. As pricing declined below the production cost threshold of these companies, shutdowns and inventory liquidations followed. Branded closeouts by once high tier western and Japanese peers in turn put margin pressure on high tier manufacturers still operating at a positive gross margin such as Trina Solar.

Another segment of the industry's losers have been comprised of less integrated component manufacturers even those with lower cost structures within China and Taiwan. The demand boom in 2010 generated unsustainably high margins even among single verticals and resulted in significant capacity expansion. Unlike large scale highly integrated leaders such as STP, YGE, and TSL, the profitability threshold for single verticals is much lower and the models for many of these fragmented producers broke as asps declined across the board.

Clear examples are evident among Taiwanese solar companies which predominantly operate as single vertical suppliers. Taiwan's top solar cell producers, Motech and Gintech, reported 2011 annual revenue declines of 27% and 35% respectively. Smaller Taiwanese peers fared far worse. For example, E-Ton reported a massive -59% net margin on revenues which in the final three quarters of 2011 combined were half of its first quarter revenues. In contrast, Trina Solar reported a 10.2% revenue increase in 2011 over 2010 despite an annual module asp decline of 45% from start to finish.

How much longer the industry's consolidation continues is the only real question for investors. Competitively positioned companies will be the ultimate survivors while the remainder will likely fail. As with all businesses, it is not a question of absolute competitiveness, but rather relative competitiveness. As bad as earnings may look for Trina Solar in any given quarter, it is likely magnitudes worse for less competitive peers. Consequently, increasingly difficult quarters for the sector's cost leaders will likely accelerate the industry's consolidation process.

After all, global demand for solar products has increased almost exponentially as costs declined. As long as demand exists, the entire industry should not implode resulting in a scorched earth scenario with no survivors. With pricing extremely competitive in the past several of quarters with no signs of abating, it appears consolidation may continue until once hundreds of solar vendors have been reduced to just a dozen or two. Only after this period winds down will profitability return for the industry's survivors. Despite a difficult year in 2011 and challenging quarters looking ahead into 2012, Trina Solar remains one of the industry's largest and cost efficient solar module producers.

Disclosure: I am long TSL, YGE.

Additional disclosure: No position in STP, FSLR.