Renesola's Prospects Remain Cloudy Despite A Well Executed 2011 Fiscal Year

| About: ReneSola Ltd. (SOL)

Once again in the fourth quarter of 2011, Renesola was able to record a number of non-operational gains that helped offset its corporate losses. Customer prepayment forfeitures, net foreign exchange gains, discounted debt repurchases, and tax benefits contributed to almost $42.7m in quarterly gains and helped offset a $26.2m inventory provision. Without this $16.5m in net non-operational benefit, SOL's Q4 loss would have been almost 50% greater than the U.S. GAAP $36.7m loss posted.

Despite surpassing shipment guidance of 280-300MW with actual fourth quarter shipments of 339.9MW, Renesola's (NYSE:SOL) operational results fell well below my estimates, which called for a $9m gross profit. Instead of positive gross margins, SOL reported an adjusted gross loss of $17.2m, which excludes the $26.2m inventory provision taken during the quarter. With Q4 revenues of $187.7m, the company surprisingly posted a rather large adjusted negative gross margin of -9.2%. This was a dramatic reversal of adjusted gross margin of 6.2% during the third quarter.

Based on statements made during the company's third quarter earnings conference call, Renesola should not have posted negative gross margin in the fourth quarter. With gross margin being an obvious relationship between costs and selling prices, the result should not have been a surprise given the amount of information SOL's management provided. On the pricing side, Renesola's Q4 silicon wafer and solar module ASPs were $0.36/watt and $0.97/watt, respectively. In comparison, my Q4 estimates assumed wafer and module ASPs of $0.37/watt and $0.97/watt respectively. Thus, Renesola's negative surprise on gross margin was not the result of pricing.

The disconnect came from the company's stated costs in the third quarter and what was actually reported in the fourth quarter. In Q3 of 2011, SOL's management gave clear detail on the company's cost metrics. After an inventory provision of $19.4m, management indicated the company's carrying costs for polysilicon and modules had been written down to $35/kg and $0.95/watt respectively. With real time procurement and production costs even lower in the fourth quarter, blended unit costs for Renesola's products should have yielded at least neutral gross margin for its silicon wafer sales and marginally positive gross margin for its module sales. Yet consolidated gross margin was -9.2% prior to a Q4 inventory provision. Miscommunication of the company's cost parameters were extremely significant in this case.

Companies can misguide on a variety of metrics which may be generally outside of its control. External forces such as demand and/or price erosion are usually tied to the market environment for the industry. As in all businesses, these factors can shift well beyond the expected ranges for a company. A company missing guidance due to these external market factors is more excusable.

However, a company's own costs should be a predictable parameter. All companies should have an exact idea of their inventory carrying costs and with over half the quarter already past, Renesola should have had a very good idea of its procurement costs for the quarter. These figures should have translated to reported costs in the fourth quarter. What makes it even more confusing is that in another statement, management directly outlined expected blended costs. Yet actual cost of goods sold in the fourth quarter were significantly higher.

Either Renesola's management did not have a firm grip of its own financials or seriously miscommunicated it during earnings conference calls. Either way, it is not exactly a reassuring sign for investors as they try to evaluate the company's earnings prospects. Unfortunately, these lapses have often been a recurring theme for Renesola, and as a result, actual reported financial results have often differed materially from implied guidance.

Despite a large negative surprise on costs, there were some positives in Renesola's fourth quarter. The upside surprise in overall unit volume was due to strong solar module shipments. The company's module shipments had been on a sequential decline for four straight quarters, but ticked up considerably to 94.5MW from 33.7MW in the prior quarter. Looking forward into 2012, the company expects annual module shipments to more than double to 600MW.

As noted in a prior Renesola review, it may be critical for the company to integrate downstream in order to generate enough gross profit just to stay profitable at the corporate level. Higher levels of integration not only provides more gross profit potential within the value chain, but also helps in securing shipment volume. By building sales channels closer to the end market, SOL can reduce the risk of its production not being placed within the market.

Additional expansion into the balance of system ("BOS") vertical could further ensure its capacity be optimally utilized. This strategy was first deployed by large western module manufacturers such as Sunpower Corp. (NASDAQ:SPWR) and First Solar (NASDAQ:FSLR) in order to counter some relative disadvantages both companies had vs. top tier low cost Chinese module suppliers such as Trina Solar (NYSE:TSL) and Yingli Green Energy (NYSE:YGE). While SPWR's solar modules offered superior efficiency, costs were also much higher even on an efficiency adjusted level after savings on BOS due to efficiency were taken into account. At the opposite spectrum, FSLR's modules were much cheaper on a per watt basis but at the cost of lower efficiency. While not uncompetitive on an absolute level, projects using SPWR or FSLR's modules were relatively less competitive from a pricing standpoint vs. top tier Chinese modules, which balanced both costs and efficiency to provide overall better value.

Without expansion into the systems segment and project development, it is arguable both Sunpower (SPWR) and First Solar (FSLR) may find it extremely difficult to place their products in an extremely competitive market where overall costs are a primary focus. For example, in FSLR's Q1 earnings report, the company expects roughly 70-80% of its annual 2012 annual module production to be internally consumed in its own self developed projects. Just a few years ago, all of the company's production was sold to third parties. With crystalline solar module production costs almost level with FSLR in recent quarters, First Solar's lower efficiency modules have become even less competitive. Without a well developed sales channel and project pipeline, First Solar's survival may be in question today.

Whether Renesola fully commits to a truly integrated strategy which includes systems development is still uncertain, but at least the company has realized the necessity to expand its downstream module segment. With recent spot market trends so unfavorable to the company's main silicon wafer capacity, Renesola would have a very difficult time generating any gross profit on sales outside of module shipments. Based on SOL's Q1 ASP guidance of $0.32-0.34/watt and $0.80/watt for silicon wafers and solar modules respectively, it is likely any gross profit would come solely from module sales.

For the first quarter, Renesola's official guidance calls for total volume of 400-420MW and revenues between $180-190m. Overall gross margin is also expected to be positive. Barring another miscommunication on internal cost metrics, a first quarter earnings estimate has been compiled below based on data disclosed in the company's Q4 earnings conference call. As usual, this estimate generally represents operational earnings and excludes unannounced non-operational gains or losses, with the exception of a small net foreign exchange loss which assumes constant hedging practices from the prior quarter.

Renesola Q1 Earnings Estimate:

  • Revenues: $183.5m
  • Wafer Shipments: 325MW at 0.34/watt = $110.5m
  • Module Shipments: 85MW at 0.80/watt = $68m
  • Total Shipments: 410MW
  • Unit Cost:
  • Wafer: 325mw at 0.34/watt = $110.5m
  • Module: 85mw at 0.77/watt = $65.5m
  • Total COGS: $176m
  • Gross Profit: $3.5m
  • Gross Margin: 1.9%
  • Operating Expenses: $25m
  • Net Interest Expense: $9m
  • Foreign Exchange Loss: $3m
  • Tax Benefit: $7.5m
  • Net Loss: -$26m
  • Diluted Share Count: 86.5m
  • EPS: -0.30

Because Renesola still has over $100m in convertible bonds outstanding, continued repurchases at discounted rates could incrementally add to U.S. GAAP results and reduce the overall expected net loss. In the fourth quarter, the company repurchased its convertible bonds at approximately 58% of par value for an $8.2m gain.

Renesola did a good job of managing its losses in 2011, with proactive non-operational measures, but this can only be continued so far. With the recent collapse in polysilicon pricing, the company's upstream polysilicon plant expansion focus announced over a year ago appears to be a mistake. Coupled with a primarily wafer centric business, it would be very difficult for Renesola to generate any gross profits at all given the spot market pricing spreads between crystalline verticals today. The company's expected annual growth in module sales will help, but profitability in this segment may lag larger established peers based on the aggressive module pricing management has indicated in the last earnings conference call.

In short, Renesola has still not given a clear strategic goal. Limited concentration in the downstream segments of the value chain suggest the company is still committed to being a silicon wafer supplier. Upstream polysilicon capacity, as well as horizontal integration in the wafer vertical, will help keep Renesola competitive on the cost front, but leave it extremely vulnerable to market forces on the demand side. Theoretically, the dislocated silicon wafer pricing will ultimately have to normalize because the entire vertical will not be able to operate at zero or negative gross margin indefinitely. Until this normalization occurs, Renesola will likely continue to operate in a state of limbo and possess less upside potential relative to higher integrated peers closer connected to end market demand.

As noted in my third quarter review (see link above), Renesola did an excellent job in managing its losses during 2011's brutal industry downturn. While operational losses were unavoidable as average selling prices ("ASP") for solar products collapsed, the company took proactive measures such as convertible bond repurchases at discounts to par value which helped bolster U.S. GAAP earnings. As a result and as suggested in my last article, Renesola was able to end 2011 with a token annual net profit when most peers posted large losses.

Disclosure: I am long TSL, YGE.

Additional disclosure: No position in SOL, FSLR, SPWR.