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For several quarters following its 2010 NYSE IPO, Jinko Solar (JKS) built a reputation of under promising and over delivering. The brutal solar industry downturn since mid-2011 quickly reversed a once stellar reporting history. For the second straight quarter, Jinko missed Wall Street estimates badly with its fourth quarter 2011 earnings report. Unlike the third quarter that missed due to unexpected charges, Jinko's Q4 missed on both operational metrics as well as additional unannounced charges.

On a US GAAP basis, Jinko Solar lost $58.3m or -2.58 in earnings per share ("EPS") which were much worse than analyst consensus of -0.47 in EPS and my -0.34 Q4 EPS estimate. Unlike the prior quarter, Jinko did not list all charges taken with the exception of a $7.3m impairment of goodwill. Based on the company's 2011 annual report, Jinko probably took another accounts receivable provision of approximately $10m which increased fourth quarter operating expenses to $41.9m vs. a mid-twenties million run rate in previous quarters.

Higher than expected losses due to charges taken in Jinko's operating expenses were only part of story. Jinko Solar also missed its operational guidance for the fourth quarter in 2011. In the third quarter, Jinko guided Q4 module shipments to a range of 180-210MW with revenues of $180-210m. While the company met its revenue range with $190.4m in quarterly revenues, it was a result of non-core silicon wafer and solar cell sales. Jinko's module shipments of 169.1MW were even below its lower boundary guidance.

Solar module sales have been the main profit driver for the company as it has been the only segment to generate positive gross margin. Fully integrated module gross margin was 5.8% but consolidated gross margin was -4.4% in Q4 2011. While another potential undisclosed inventory provision may have contributed to negative quarterly gross margin, Jinko sold its upstream components at negative margins inline with the industry's dislocated pricing between individual verticals.

While Jinko Solar initially dismissed any negative effects from its Zhejiang environmental incident in 2011, the company reversed tone in its Q4 earnings conference call and admitted the accident affected its brand bankability as well as average selling prices ("ASP"). While Jinko explained certain banks only held off sponsoring its branded modules until the incident was completely resolved, both the company's module shipment volume as well as selling prices were negatively impacted in the fourth quarter.

The company's implied module ASPs of just under $0.97/watt was at the low end of its $0.95-1.05/watt and my $1.00/watt estimate. In contrast, Jinko's four larger US listed Chinese peers Suntech Power (STP), Yingli Green Energy (YGE), Trina Solar (TSL), and Canadian Solar (CSIQ) posted Q4 2011 module ASPs of $1.12/watt, $1.11/watt, $1.01/watt and $1.02/watt, respectively. Not only did the company have to lower pricing in order to move volume, but also at much lower average prices than closely structured peers.

As noted in my previous Jinko Solar reviews, key material procurement at JKS varied from its larger integrated peers such as TSL and YGE. Outside of small legacy polysilicon supply contracts, Jinko buys almost all of its silicon requirements at the spot market while STP, YGE, and TSL historically procured 60-80% of silicon through long term contracts. This left Jinko vulnerable to high polysilicon ASPs in the second half of 2010 but also allowed the company to blend its silicon inventory carrying costs lower at a faster rate as prices collapsed in late 2011. Although Jinko's blended silicon costs in Q4 2011 were still relatively high, the company was still able to achieve the lowest module unit cost among US listed peers at $0.91/watt. Trina Solar, historically among the low cost leaders in the industry, reported an integrated module unit cost of $0.94/watt in the same period.

Jinko Solar's cost structure has been among its key positives. The ability to blend inventory costs lower at a quicker rate combined with industry low non-silicon module manufacturing costs of $0.64/watt helped Jinko absorb lower module ASPs in the fourth quarter. Nevertheless, the collapse in solar product pricing since mid-2011 has taken a toll on all manufacturers including the lowest cost producers such as Jinko Solar. In just two quarters, Jinko's integrated module gross margin collapsed from 30.5% in Q2, to 18.4% in Q3, to just 5.8% in Q4 2011. However, the company's module gross margin of under $0.06/watt in the fourth quarter may have hit a trough based on comments by industry peers.

Since the bulk of polysilicon's pricing decline began only since the fourth quarter of last year, Jinko's ability to blend its silicon carrying costs lower quickly was not fully reflected in Q4 2011. Spot market purchasing of polysilicon in Q4 2011 and Q1 2012 combined with relatively low inventory should allow Jinko to decrease its polysilicon cost component by $0.08-0.09/watt in the first quarter of this year. If the company can lower its module processing costs inline with peers which have already reported, it is likely Jinko could lower its module unit cost to $0.80/watt. As long as the company's module ASPs decline inline with peers, its per watt gross profit on module shipments should expand beyond the sub $0.06/watt level at the end of 2011.

Whether Jinko Solar's environmental incident last year is fully behind the company is still in question. If the event was just a short term hiccup as viewed by Jinko's management, shipments as well as pricing should revert to levels inline with its direct Chinese peers. For the first quarter 2012, JKS guided for a slight sequential module shipment increase to 170-190MW despite seasonal weakness typically observed in the Q1. With this limited quarterly guidance, a first quarter earnings estimate has been compiled below using metrics inline with JKS's direct peers. As usual, this estimate generally represents operational earnings and thus excludes unannounced gains or charges the company may report. Jinko Solar plans to announce Q1 2012 earnings on June 20, 2012.

JKS Q1 2012 Earnings Estimate:

Revenues: $170m

Shipments: 180MW module

Asps: $0.89/watt module

Module Unit Cost: $0.80/watt

Gross Profit: 180MW x $0.09/watt = $16m

Gross Margin: 9.4%

Operating Expenses: $25m

Net Interest Expense: $9m

Net Foreign Exchange Gain: $3m

Tax Benefit: $2m

Net Loss: -$13m

Diluted Share Count: 23m

EPS: -0.57

Expected non-operational items such as net foreign exchange translations as well as the company's change in fair market derivatives linked to its convertible bonds should be limited in the first quarter. Assuming Jinko did not alter its hedging strategy, most of its Q4 2011 net foreign exchange loss should reverse as the euro gained slightly vs. the USD. In addition, with only marginal movement in the company's listed share price in the first quarter, the change in fair market value of its derivatives linked to its convertible bonds should be minor.

Similar to other Chinese solar cell manufacturers, Jinko may also be required to take provisions on shipments to the US after recent anti-subsidy and anti-dumping rulings against Chinese solar cells. Direct Chinese peers such as TSL, STP and YGE have already taken tariff provisions of $26.2m, $19.2m, and $13.7m respectively.

Lastly with the recent collapse of Hoku's polysilicon project, Jinko Solar may need to write off up to $20m of prepayments for a 2009 long term polysilicon supply contract. Unfortunately for Jinko, one of the few long term supply contracts the company had exposure was to absolutely the wrong supplier. Jinko was not alone in Hoku exposure as several other peers including Suntech had exposure several times larger.

Although it is questionable Jinko Solar can achieve a quarterly profit in 2012 from just module sales, it like many large peers has taken the next evolutionary step of expanding into downstream systems integration where not only potential revenue but also gross margin are significantly higher. For 2012, the company expects 100-150MW in solar projects based in China that could yield roughly 20% of its annual revenues. Gross margin is also expected to be around 20% on these projects. The company's early sample indication of $1.80/watt project ASP for 30MW of projects could lead to significant incremental revenues and gross profit in the second half of 2012 when most projects in China are built. Along with seasonally higher second half module shipments, additional profitability from solar project sales would most likely be enough for Jinko Solar to return to corporate profitability.

2012 should be a pivotal year for Jinko Solar as the past year has been for the entire industry as less competitive peers have been forced out of business. Although Jinko Solar's environmental accident last year came at a very untimely period as industry consolidation had already raised bankability concerns for mid-tier suppliers, the company is still among the industry's highest integrated and lowest cost producers. If combined with successful brand building, Jinko Solar still should have advantages over most of the industry. JKS investors should thus carefully monitor the company's ability to not maintain but gain market share throughout 2012 as the industry field continues to narrow.

Source: Jinko Solar Q1 2012 Earnings Preview

Additional disclosure: No position in STP.