A Final Dead Cat Bounce Before The Big Crash In Canadian Solar?

| About: Canadian Solar (CSIQ)
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Fundamentals:

Canadian Solar Inc. (NASDAQ:CSIQ) is another troubled solar company that is near financial distress because of the conditions on the solar market. The company is one of the losers in the Jobs Transformation Scheme.

Chart 1: Canadian Solar Net Income and Equity: 2009-2012

The company has been losing money for the last two years, like its peers. The company's equity has shrunken from $534 million to about $301.58 million. The company's net loss is in an up-trend, it keeps increasing. If the company continues to burn money at the current rate, it will have a negative equity by Q2 2014 - Q3 2014.

Chart 2: Canadian Solar Revenue, Shipments and Gross Margin: Q1 2010 - Q4 2012

As illustrated in Chart 2, the company experienced aggressive shipments of modules growth from Q2 2010 to Q4 2011. The company's shipments of modules rose by 140.6% in that period, from 181.2 MW in Q2 2010 to 436 MW in Q4 2011. The company's shipments have stagnated since the peak in Q4 2011.

The company's gross margin has decreased in the same period, despite the increase in shipments of modules, from 17.5% in Q3 2010 to 4.75% in Q4 2012. That is due to the decreasing prices in the PV market, due to the Jobs Transformation Scheme. That has caused the company's revenue to decrease from $336.9 million in Q1 2010 to $295 million in Q4 2012, despite 404 MW shipped in Q4 2012 compared to 185 MW in Q1 2010.

The following chart shows the development in the company's Average Selling Price ("ASP") per W:
Chart 3: Canadian Solar ASP (calculated as Total Revenue / Total Shipments) Q1 2010 - Q4 2012.

The chart shows that the company's ASP has decreased by 59.9% from Q1 2010 to Q4 2012, from $1.82 to $0.73. The company has invested in R&D in order to adapt to the falling prices in the PV market. That has caused the company's average production costs per W ("APC") to decrease from $1.31 in Q2 2011 to $0.56 in Q4 2012, according to the company's investor presentation.

Unfortunately for the company that decrease in APC hasn’t been enough for the company to turn profitable. Jinko Solar’s (NYSE:JKS) (which is another PV manufacturer) cell efficiency was 18.6% at the end of 2011. Jinko Solar’s ASP was $0.62 in Q4 2012. Canadian Solar's efficiency for its multi-crystalline cells is 18.5%. Canadian Solar states that it had reached 21.5% efficiency on its mono-crystalline in the lab. As Canadian Solar's 21.5% efficiency solar cells aren't ready for commercialization, one could expect that its ASP would decrease to the same level as Jinko Solar’s, even though Jinko Solar’s efficiency are higher than Canadian Solar's efficiency. The following is a screenshot from the company’s recent 20-F filing.


As you can see in the 20-F filing, the company’s total solution business accounted for approximately 3,5% of the company’s MW sold, and the solar module business accounted for the remaining 96,5%. What is more interesting is how big a share of revenue that each business accounts for. The following is another screenshot from the company’s 20-F filing:



Notice the ASP for 2012 for the two different businesses. The solar module business’ ASP was 0.77 was in 2012. The reason why the ASP differs from the quarterly is because the ASP is calculated for the entire year of 2012, while the quarterly is calculated for a quarter. The company’s ASP for its total solution business was 2.8 in 2012. The company stated in its latest conference call that its gross margin from its total solution business tends to be in the 15%-20% range. With an ASP of 2.8 that means that the company’s APC for its total solution business is between 2.1 and 2.24. The average of that are 2.17.

The calculation for Canadian Solar’s module business will look like this, if Canadian Solar's ASP for its PV module falls to the Jinko Solar level, while its ASP for its total solution business stays at the 2,8-level:

Shipments 2013 average outlook - module business
1350
MW
ASP Q4 2012
0,62
USD
APC expectation
0,56
USD
Gross margin per W - module business
0,06
USD
Expected Gross profit - module business
81
Millions USD
Shipments 2013 average outlook - total solution business
400
MW
ASP 2013 expectation* - total solution business
2,8
USD
APC 2013 expectation*- total solution business
2,17
USD
Gross margin per W - total solution business
0,63
USD
Expected Gross Profit - total solution business
252
Millions USD
Expected operating expenses 2013
400
Millions USD
Expected interest expenses 2013
54
Millions USD
Expected net income
-121
Millions USD
Table 1

As you can see in table 1 the company’s expected net income will be approximately -121 millions USD in 2013, if the company’s ASP for its total solution business stays at the 2.8-level and ASP for its module business stays at the 0.62-level. I expect the company’s ASP for its total solution business to decrease in 2013. I expect it to be in the 2.2 to 2.5-range. I will write an article on why I believe that ASAP. The average of that are 2.3. If one assumes that, the calculation will look like this:

Shipments 2013 average outlook - module business
1350
MW
ASP Q4 2012
0,62
USD
APC expectation
0,56
USD
Gross margin per W - module business
0,06
USD
Expected Gross profit - module business
81
Millions USD
Shipments 2013 average outlook - total solution business
400
MW
ASP 2013 expectation* - total solution business
2,3
USD
APC 2013 expectation*- total solution business
2,17
USD
Gross margin per W - total solution business
0,13
USD
Expected Gross Profit - total solution business
52
Millions USD
Expected operating expenses 2013
400
Millions USD
Expected interest expenses 2013
54
Millions USD
Expected net income
-321
Millions USD
Table 2

As one can see in table 2 if that is the case the company will lose more than its equity. The company’s equity was approximately 301 millions USD as of December 30, 2012.

If one looks at the company's financial statements, the company's APC is actually higher than what the company stated in its March 2013 investor presentation. According to the company's financial statements, the company's real APC looks like this:

Chart 4: Canadian Solar Average Production Costs per W Q1 2012 to Q4 2012 (COGS / Total Shipments)

The chart clearly shows that the company's APC is substantial higher than stated in the company's March 2013 investor presentation. If one makes the former calculations with the "real numbers," the result will differ by a substantial amount.

Shipments 2013 average outlook - module business
1350
MW
ASP Q4 2012
0,62
USD
APC expectation
0,71
USD
Gross margin per W - module business
-0,09
USD
Expected Gross profit - module business
-121,5
Millions USD
Shipments 2013 average outlook - total solution business
400
MW
ASP 2013 expectation* - total solution business
2,3
USD
APC 2013 expectation*- total solution business
2,17
USD
Gross margin per W - total solution business
0,13
USD
Expected Gross Profit - total solution business
52
Millions USD
Expected operating expenses 2013
400
Millions USD
Expected interest expenses 2013
54
Millions USD
Expected net income
-523,5
Millions USD
Table 3

In that case the company will lose 523,5 millions USD, which is gain higher than the company’s equity of 301 millions USD.
In either scenario the company will lose more than its equity, which was $301.58 million as of 30 December 2012.
The Bull Case

As you may have noticed, CSIQ and nearly every other solar stock rallied in the last two weeks. The solar stocks rallied due to a series of statements by multiple entities and persons. First Solar Incorporation released the first news on 9th April 2013. FSLR issued a press release that included Full-Year 2013 financial guidance, and 2014-2015 guidance.

First Solar stated that it expects its gross margin to be between 20% and 22%, which is lower than the company's gross margin in the previous years. The following chart shows the development in First Solar's gross margin from 2009 to 2012:

So it's not because management expects the price of PV modules is going to rise that the company expects diluted EPS between $4 and $4.5. It's because of optimistic revenue growth expectations and revenue recognition from the Desert sunlight project. The company expects lower gross margins, despite falling production costs. That ultimately means that they expect falling ASP, which is bearish for PV manufacturers.

The next news that boosted solar stocks was Trina Solar's CEO statement regarding his optimistic expectations about the future of the PV market. He stated that he expects the prices of PV modules to rise in 2013. He stated the same in early 2012, where the PV module prices plummeted. So I don't trust his word.

JinkoSolar Holding Co., another solar company, announced earnings on 10th April 2013. The company's earnings showed that the company's margins and ASP worsened in Q4 2012, compared to the previous quarters. That is bearish news for the solar manufacturing industry, as it showed that prices have decreased more than expected.

On 23rd April IHS released a report that showed that the average selling price for Chinese crystalline silicon (c-Si) PV modules shipped to the European Union increased by 4 percent in March. Investors assumed that as being bullish for Chinese PV manufacturers, despite that further down in the report, the following is written:

"On the other hand, prices also are rising because of anti-dumping legislation in the European Union, which is negatively impacting sales for Chinese suppliers."

I know what you are thinking: "Canadian Solar is a Canadian PV manufacturer, not a Chinese manufacturer."
The following screenshots are taken from the company's latest 20-F filing.

As you can read in the 20-F filling, all the production entities of CSIQ are placed in the People's Republic of China. That means that the company won't benefit from the rise in prices in Europe, as the rise is mostly due to the anti-dumping tariffs on Chinese modules.

The Technical Side

The weekly chart indicates that the company is near overbought territory, and has formed a bearish divergence. That indicates that the stock is likely to fall in the near-term. The chart also shows that every time the stock has rallied in the past, the stock has quickly decreased afterwards.

Conclusion

I can't understand why anybody would buy a share in a financially distressed company that runs huge deficits. The only logical explanation that I can find, behind the latest buying of this stock, is shorts covering their positions. According to Yahoo! Finance there were 1.92 million shares short as of 15th April 2013. The following chart shows the price action of CSIQ from 04/16/13 to 04/26/13:

What is interesting about this chart is that it shows that multiple short squeezes have taken place in that time frame. I can derive that from the near horizontal price action in some period of times on increased volume. 5.9 million shares changed hands in week 17, which indicates that this short squeeze might be over, as the shorts are probably done covering their positions.

I think this short-term up-trend in CSIQ is a dead cat bounce, and that CSIQ is most likely to seek bankruptcy protection within the next two years. In order to profit from that, one can buy longer dated put options, sell call options or simply short the stock. Another thing worth watching is the planned up to 67.9% anti-dumping tariffs in Europe on Chinese PV modules.

In order to get a better understanding of what is going on in the PV manufacturing industry, I recommend reading this research note.
*This is the expectation of Abdalla Al-ayrot.

Disclosure: I am short CSIQ, YGE, LDK, STP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short the disclosed stocks by being long put options. Abdalla Al-ayrot is not an investment advisory service, nor a registered investment advisor or broker-dealer and does not purport to tell or suggest which securities customers should buy or sell for themselves. Abdalla Al-ayrot may hold positions in the stocks or industries discussed here. You understand and acknowledge that there is a very high degree of risk involved in trading securities. Abdalla Al-ayrot has no responsibility or liability for your trading and investment results. Factual statements on the Company’s website, or in its publications, are made as of the date stated and are subject to change without notice.