In the past year average selling prices("ASP") for solar products fell dramatically across the board. As pricing dropped by as much as 70% in some verticals, higher cost business models became exposed. While the early bankruptcy victims have been Western companies such as Solyndra, Evergreen Solar, Solar Millenium, and once industry leading solar cell manufacturer Q-Cells, some once labeled low cost Chinese manufacturers have also dipped into negative gross margin territory. Hanwha SolarOne (HSOL) was never a low cost leader among US listed Chinese module manufacturers, but its cost structure was low enough to generate respectable earnings in the past. Lower industry pricing has accelerated sector wide consolidation which could potentially marginalize HSOL unless it can lower its cost structure quickly.
While fourth quarter 2011 was generally bad for most solar companies, it was especially a messy quarter for Hanwha SolarOne. HSOL's Q4 2011 earnings report raised serious warning flags because unlike many peers it was not able to lower production costs inline with market pricing declines. While the company's shipments were still relatively strong at 189.1MW, gross margin fell deeply into negative territory. Even excluding some charges which affected cost of goods sold, HSOL posted adjusted Q4 gross margin of negative 20.1% on revenues of $155.4m. Including several non-cash charges totaling $94.8m, US GAAP losses ballooned to $132.3m, or -1.76 in quarterly earnings per share.
Despite module ASPs inline with my $1.00/watt estimate, blended unit production cost ran well above expectations. Excluding $64.7m consisting of an inventory write down and a supply prepayment provision, blended module unit cost was $1.16/watt. HSOL also noted internal unit cost using its own in house produced silicon wafers was $1.03/watt. In other words, the company sold modules at even below real time procurement cost levels.
Unlike larger Chinese module producers such as Trina Solar (TSL), Yingli Green Energy (YGE), and Suntech Power (STP), Hanwha SolarOne has not been able to reduce its production costs by the same magnitude of market pricing declines. In the fourth quarter, HSOL was only able to reduce its adjusted production costs from $1.20/watt in the third quarter to $1.16/watt. In comparison, Trina Solar reduced its in house unit cost from $1.04/watt to $0.94/watt while Yingli reduced its costs from $1.03/watt to $0.97/watt in the same period. Suntech did not disclose its exact unit cost but I estimate it fell from approximately $1.12/watt in Q3 to $1.00/watt in Q4 2011. While the rate of unit cost reductions varied, TSL, YGE, and STP all posted positive gross margin in the fourth quarter with module costs on average 20% lower than HSOL.
Unless Hanwha SolarOne can reduce its real time module production cost dramatically, it runs the risk of being squeezed out as the industry continues to consolidate. Operating at corporate losses is one thing, but operating at -20% gross margin is entirely a different story. Irreversible negative gross margin due to the inability to reduce production costs have been one of the key reasons why solar companies have failed in the past. The key question is whether HSOL's margins are reversible. Based on management's comments in its Q4 earnings conference call, the company is dangerously close to the borderline of survival and failure.
It is important to note HSOL does not have a good track record of delivering production cost targets. The fourth quarter of 2011 was an example how the company failed in reducing unit cost inline with market ASP declines. Management stated a non-silicon processing cost target in the low $0.60s/watt, but whether the company can achieve this from a high $0.70/watt level remains to be seen given its execution history. Still, this target is above the ranges of larger direct Chinese peers. With normalized per watt gross margin potentially below $0.20/watt even for the industry's cost leaders such as Trina Solar, any disadvantage would likely tip corporate results into the red.
For the first quarter of 2012, prospects for Hanwha Solarone appear dim. With module ASPs indicated to drop to around $0.85/watt, the company's gross margin will likely remain deep in the red. A Q1 2012 earnings estimate has been compiled using metrics stated in the company's prior earnings release and conference call. While additional items discussed below may also apply, this estimate mostly represent Hanwha SolarOne's operating earnings.
HSOL Q1 2012 Earnings Estimate:
- Revenues: $120m
- Shipments: 130MW module, 30MW oem
- Asps: $0.85/watt module, $0.30/watt oem
- Unit Costs: $1.05/watt module, $0.30/watt oem
- Gross Loss: -$26m
- Gross Margin: -21.7%
- Operating Costs: $30m
- Net Interest Expense: $6m
- Tax Benefit: $12m
- Net Loss: -$50m
- Diluted Share Count: 84.2m
- EPS: -0.59
Normal non-operational items which may alter this raw estimate are net foreign exchange translations as well as the mark to market change in derivatives linked to the company's convertible bonds. HSOL has typically hedged its currency exposure well and the net effect will likely be minimal. In addition with its listed share price so low with little absolute changes during the quarter, the change in fair value of its convertible bond derivatives will likely be very small outside of repurchases made at discounts to par value.
With 33% of its fourth quarter shipments to the US, up dramatically from 13% in the third quarter, Hanwha SolarOne's increased US exposure could also increase the negative impact from recent anti-dumping rulings made by the U.S. Department of Commerce. Peers such as Trina Solar and Suntech Power have already reported provisions of $26.2m and $19.2m respectively in Q1 2012. Although HSOL's absolute shipment level is much lower, any volume to the US could similarly result in tariff provisions.
In addition, continued declines in module ASPs especially at already negative gross margin will likely incur another inventory provision. Lower inventory levels at HSOL relative to other peers will help, but it is still likely the company will record another provision to the degree of expected ASP declines in the first quarter. Based on the company's inventory level at the end of 2011, another write down of $10-15m might occur.
Lastly while Hanwha SolarOne has already written off many of its legacy assets such as a $54.4m provision on prepayments for supply contracts in the fourth quarter alone. With over $100m left in prepayments according to the company's 2011 annual report and the recent collapse of Hoku Corp., HSOL will likely write off completely any related prepayments remaining totaling as much as $50m.
As noted in my previous HSOL article, the company is a high risk play on the solar sector. As a stand alone company given its recent operating performance, its survival past the current consolidation wave in the solar industry remains highly questionable. However as a business unit of a larger Hanwha Corp. conglomerate which has already poured in hundreds of millions into the company, variables may be altered enough to maintain ongoing operations.
Even with higher production costs which may hinder HSOL's chances of producing any corporate profits, on a cash production level the company can still produce a product at a cost point which allows for solar projects potentially sponsored by its parent to be economically justifiable. This link may be the only value shareholders have left if HSOL's parent decides to continue expanding its solar business with downstream projects. How much Hanwha Corp. values the remaining 50.1% of HSOL it does not already own remains in question. At least from recent earnings reports, Hanwha SolarOne's risk profile continues to increase while potential rewards diminish.
Additional disclosure: No position in STP.