In many ways Suntech Power's (STP) first quarter earnings report provided some supportive insight into the process of consolidation currently underway in the solar industry. The financial numbers were of course less than constructive, though much as expected as pricing pressures continue to make life difficult for the sector. However, perhaps of more interest were the company's insights into the inroads being made in the industry regarding the over supply situation and their own progress on reducing production costs. Both of these factors point to a process which will eventually right the industry, leaving a bright future for those competitive producers who survive the current turmoil. Light at the end of the tunnel. However, the tunnel still seems to be about 6 to 12 months long. Given the market's general lack of ability to be significantly forward-looking in the current difficult environment that probably means that any hopes for sustained rally are premature for now.
On the financial numbers themselves, much as expected the company reported a seasonally weak first quarter. Shipments were down 26.9% on the quarter and 22.1% on the year. Revenues came in at $409.5m, down 53% on the year. Gross profit collapsed to a mere $2.4m and the gross margin came in at only 0.6%. However, this largely reflected a preliminary provision for US countervailing and anti-dumping duties of $19.2m, or 4.7% of revenues. Excluding this provision, the gross margin was at the high end of the company's 3-6% guidance.
The net loss came in at $133m or 74 cents per diluted ADS. This was 26 cents worse than the 50 cents expected by the consensus.
From a big picture perspective, these numbers are not particularly exciting in either direction. The 'surprise' against the consensus was the company's decision to take a provision on the tariff issue. However, the company also made it clear that there will be no need for further US duty-related charges in following quarters - mainly as a result of the fact that they have been able to adjust their global supply chain to ensure that their product going into the US is sourced from outside of China.
Indeed, in the earnings call, Chief Commercial Officer Andrew Beebe offered the following:
"We made a transition to globally sourced cells, not just Taiwan, but globally sourced cells as timely and as quickly as we thought was prudent from a product standpoint ... from this point forward, there will be no products going to the US that will have any tariffs applied to them".
Meanwhile, CFO David King added the company's view that "... the accounting charge may get reversed at the final decision level".
Outside, of the financial numbers themselves, the real interest was on the company's view of the consolidation process underway both at STP and in the industry as a whole. Given STP's leading position in the industry their insight is of course both valuable and instructive. Amongst all the detailed analysis, there were basically three clear takeaways from the earnings call.
Firstly, the company remains optimistic about overall demand, guiding towards a 20% increase in shipments in Q2. Moreover, they continue to see shipments for the year as a whole of some 2.1 to 2.5 GWs, a range straddling their total capacity of some 2.4 GWs. In regional terms, they are still seeing good demand out of Europe and the Americas. And of course going forward countries like Japan, China and Saudi Arabia now have significant programs in place. China is now a 4-5 GW market and that number is likely to rise to 10 GW in coming years. Meanwhile, Saudi Arabia has just announced a plan to put 41 GW in place by 2032 and a meaningful level of orders is likely to be seen in 2013.
Secondly, the company clearly sees consolidation particularly within China as already helping to reduce the excess supply situation in the industry. In the Q&A session CEO Zhengrong Shi offered the following insight:
"In China, certainly there is a lot of idle capacity here. And currently as we know is oversupply situation and every player has to optimize their cost structure and always minimize spend structure. So, I think production and rationalization is very reasonable. I think most companies are doing that here in China".
Clearly, the major problem for the solar industry has been that Chinese companies in particular were too aggressive in building out capacity in the past, leading to massive over supply. Indeed until the fourth quarter of last year the industry saw very little action to reign in capacity plans. The bottom line is that it seems reasonable to suggest that there now appears to be clear evidence that genuine consolidation is taking place. STP itself intends to hold their global cell capacity at 2.4 GW, with intended capex expenditures due solely to continuing costs related to previous projects. Moreover, insolvencies in Germany and elsewhere of course only add to the necessary process of consolidation in the industry. Together with demand expansion in markets like China and Saudi Arabia this will eventually lead to a more positive supply demand situation for solar as whole.
Lastly, STP itself is looking at solid progress on costs over the year. The company indicated that their own total production costs fell by 6% in Q1 over the previous quarter and they expect total module costs to be around 90 to 95 cents per watt in Q2. Moreover, during the earnings call, the company indicated that they have a high degree of confidence that they will be able to get poly to module conversion costs down to 60 cents per watt by year end - ten cents less than previously discussed. Given their expected average poly costs that should see total module costs fall to below 75 cents.
These cost developments are of course what is required to continue to drive the industry towards grid parity and also to help the most competitive players deal with falling average selling prices. Trina solar (TSL) has indicated that they are already at poly to module conversion costs of 58 cents and expect those costs to fall to 50 cents or below by year end - ten cents below STP's target. That represents a significant degree of competition for STP and is certainly supportive of Trina. At the same time, STP is generally seen to provide higher end product and as a result generates higher ASPs over their product range. It is highly likely that the solar market has room for all of the tier one vertically-integrated Chinese players such as STP and Trina. The pain is likely to fall largely on tier two and three players alongside thin film players such as First Solar (FSLR) who will find it very difficult to compete with the falling cost structures being delivered by the most competitive poly-based players.
In conclusion, having taken advantage of the rally in solar at the beginning of the year (see here), I recommended taking profits on February 10th (see here) - which pretty much proved to be the high of the year for solar. From those highs at time of writing STP is now down -53%, whilst Trina is down -43%, Yingli (YGE) is down -51% and the overall Guggenheim Solar ETF (TAN) is down -50%. With solar so heavily beaten up and with a good amount of straws in the wind pointing to a positive process of consolidation, one might be tempted to look for a good trading rally from here if the overall market was in a forward-looking mode.
However, the overall market and investor sentiment is weak, with the situation in Europe a major uncertainty. This suggests that the market is likely to be defensive and short-term orientated for now. Meanwhile, even STP's best guess is that industry profitability is 6 to 12 months away. The bottom line is that it continues to seem reasonable to keep your powder dry and wait for a buy opportunity further down the line.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.