Trina Solar's (TSL) struggles continued in the first quarter of 2012 as it once again missed its shipment guidance of 400-430MW with actual volume at 380MW. As noted in my prior TSL articles, Trina had in the past been one of the most accurate solar companies in terms of forward projections. Not immune to the overall destructive macro-dynamics in the solar industry, Trina Solar's Q1 shortfall was the fourth in the past five quarters the company in one form or another missed its own expectations. Unfortunately for investors, this trend continued as Trina recently negatively pre-announced its second quarter expectations to be reported on August 21, 2012.
According to Trina Solar, its Q1 2012 shipment shortfall was due to revenue recognition for shipments sold but not delivered by the end of the quarter. While bad for first quarter numbers, delayed revenue recognition typically meant a boost in the following quarter's top line. Yet TSL's Q2 warning was dramatic as shipment expectations was lowered from 500-520MW to 390-420MW. With 50MW of delayed recognition volume shifted from the first to second quarter, Trina's miss was even more extreme. At face value and apart of additional revenue recognition issues, this implied business conditions deteriorated to a near standstill in the final month of the second quarter.
There were plenty of reasons why business conditions may have worsened after Trina Solar gave second quarter guidance in late May. Although US anti-dumping and anti-subsidy rulings on Chinese solar products had already been announced, its ultimate impact on demand regardless of pricing was still uncertain. As Trina Solar mentioned in its Q1 earnings conference call, the company could deal with the economic ramification regarding US tariff announcements. TSL had already taken large but manageable tariff provisions for shipments already delivered to the US. In addition, manufacturing for upstream components used for US shipments were also in the process of being outsourced.
Module average selling prices("ASP") which had held steady in the first few months of 2012 started to decline meaningfully in late May. In the final weeks of the second quarter, module ASPs dropped by 10-15% based on spot pricing quoted by PVinsights. More significantly, the spread between silicon wafer/solar cell component pricing and module ASPs started to collapse correcting months of irrational upstream pricing.
Lower tier solar module manufacturers that were able to ink positive gross margin off liquidated upstream component procurement could no longer make money. Many companies in this lower tier category which had used price as a selling point were starting to get squeezed out of the market as module ASPs declined while upstream component pricing remained leveled. Similar to upstream silicon wafer and solar cell peers that had collapsed in prior months, less integrated downstream module producers may be starting to fail. As a result, solar modules being liquidated by newly defunct cases may have contributed to recent ASP declines as well as demand pressure for higher tier premium pricing providers such as Trina Solar.
Lower demand at lower pricing was only part of the issue pre-announced by Trina Solar. As seen in prior quarters which saw meaningful module ASP declines, inventory provisions often resulted. Trina now expects to take a $26-28m provision for both inventory write-downs as well as US anti-dumping/subsidy rulings. With less than a $10m tariff provision expected based on management's remarks during TSL's Q1 earnings conference call, Q2's inventory provision may range up to $20m.
Unfortunately, bad news did not stop there. Due to the continued solar industry consolidation cycle, Trina will take an additional $45-48m receivables provision for overdue accounts. In additional, the euro's 5% decline vs. the usd in Q2 will cause additional net foreign exchange losses based on TSL's euro and currency hedging exposure. Net foreign exchange losses for the second quarter are expected to range between $22-23m. In all, total non-operational charges in the quarter may be as high as $99m potentially making Q2 2012 one of the worse quarters in the company's history.
The only bit of good news left for investors in Trina's pre-announcement is that gross margin should range between 7-9% despite $26-28m in provisions which affect cost of goods sold. While lower than TSL's original 10% guidance, the new range suggests the miss is even less than the unexpected impact from Q2's inventory provision. In other words, either Trina's module ASPs remained strong and/or cost reductions continued to track well ahead of expectations. While Trina Solar will likely report large corporate losses in the second quarter, what continues to set the company apart from most peers is the operational ability to generate industry leading positive gross margin for component products that are being liquidated in an oversupplied market.
Based on Trina's pre-announcement as detailed above, a second quarter earnings estimate has been compiled below.
TSL Q2 Earnings Estimate:
Blended Unit Costs: $0.72/watt
Gross Profit: 420MW x $0.12 = $51m - Inventory/Tariff Provision $26m
Gross Margin: $25m / $353 = 7.1%
Operating Costs: $55m + $45m Receivables Provision
Net Interest Expense: $9m
Net Foreign Exchange Loss: $22m
Tax Benefit: $10m
Net Loss: -$96m
Diluted Share Count: 70.6m
While the headline numbers will likely appear awful, the majority of Trina Solar's Q2 net loss will likely be the result of non-operational charges. On an operational level, the company has generally been operating around the break even mark despite ongoing collapses by less competitive peers.
At some point, inventory provisions will end as product ASPs stabilize at sustainable levels once industry liquidation abates. With retro-active US tariffs on Chinese solar cells already announced, tariff provisions should also cease beyond the second quarter at least as it pertains to the US market. Net foreign exchange translations also tend towards neutral over long periods as long as key currencies stay in a general range. Despite wild quarterly changes between the euro and usd, exchange rates have remained within the 1.35 plus/minus 15% level for the past 8 years. While these charges compound for a horrendous second quarter, investors should not view them as ongoing issues.
Looking into the second half of 2012, it is difficult to make any predictions especially when companies with the most insight like Trina Solar continually miss its own forecasts. The final wave of lower tier downstream module manufacturing failures will likely keep margins even for the most competitive companies low. Regardless of companies which increase or decrease shipment expectations, the end result will unlikely be materially different at current gross margin profiles.
Until industry consolidation draws to a close, it is unlikely any component manufacturer will experience gross margin high enough to be meaningfully profitable. Companies which have systems and project exposure may be the only companies that can turn a reasonable profit in the near term. While First Solar's (FSLR) manufacturing cost disadvantage vs. large scale Chinese peers such as Trina Solar have all but marginalized third party sales, FSLR has been able to use its products internally for higher gross margin solar projects.
Most large scale Chinese solar manufacturers including Trina Solar have noted significant Chinese demand increases which are second half weighted. TSL for example has guided its Chinese exposure may be as high as 500MW, or as much as 25% of its overall annual shipments most of which are expected to be realized in the second half of 2012. While TSL has not given exact detail on its Chinese exposure, some of volume within China may have project exposure as several US listed Chinese solar peers have already disclosed. Trina's solar project exposure will likely be the deciding factor which may turn the company profitable in the second half.
Regardless of Trina Solar's near term corporate results, investors should focus on the longer term horizon. For investors who believe in the solar industry, the most competitive companies that survive the current brutal consolidation period should eventually see gross margin return to sustainable levels. Despite a likely gruesome second quarter, Trina Solar remains one of the largest scale and lowest cost manufacturers with among the best balance sheet in the industry.
Disclosure: I am long TSL.
Additional disclosure: No position in FSLR.