As we have written before, ReneSola Ltd (NYSE:SOL) has been priced to fail. With uncompetitive module cost structure and polysilicon cost structure, the Company has been at the mercy of industry dynamics and depended heavily on good tidings in the solar industry. In our earlier article, we estimated that it would take a few good quarters of profitability for the Company to improve its survivability.
However, concurrent with its Q2 results, ReneSola unveiled a new business model yesterday which makes near term survival of the Company a faith accompli. By far the most important aspect of the Company's second quarter conference call was the management commentary indicating a fundamental shift in the Company's business model. The nature of the shift can be summarized with two comments from the Company's conference call.
1. In response to an analyst question about 2014 volume guidance, Xianshou Li, the CEO of ReneSola, said:
"So, Patrick, to answer your question about the guidance, the full-year guidance, we actually have adjusted our strategy regarding the shipments. We don't really now focus too much on the quantity, the total shipments for a full year. Rather, we would focus on the profitability."
Some investors may see this commentary as backpedalling on the 2014 guidance and some others may not attribute much value to it. However, this commentary is significant in context of Chinese solar industry where the typical mantra is "volume first and profits will follow". This volume driven modus operandi has led to a near collapse of the Chinese and global solar industry but surprisingly very few Chinese companies have shown the willingness to break the vicious cycle of profitless prosperity.
2. The second and more significant strategic element came in response to an analyst question about selling internal capacity (something that we proposed in our article: Does It Make Sense To Breakup ReneSola? ). Mr. Li responded to that question as follows:
"So, Phil, currently we have under our PPE about $800 million in PPE assets, and currently the whole depreciation is around $100 per year. So, in 3 to 5 years, if you're counting the depreciation expense, we can have cash back around $300 to $500 per year. So going forward, our total asset, the scale of our total assets will be smaller and smaller, so we will not expand any of our internal capacity."
What Mr. Li effectively said is that instead of selling its inefficient assets, the Company will milk the assets for rest of their useful life. While we proposed divesting the assets, we believe the solution being adopted by ReneSola management is superior.
The above two bits of commentary combined imply that the Company has formulated a strategy to phase out its current asset base and is evolving in to a pure asset light OEM company. This has several implications to investors:
- ReneSola is going to have dramatically less capex going forward which will considerably reduce capital needs and risk. ReneSola will likely milk its manufacturing assets as long as they provide a decent return on an EBITDA basis and then repurpose the assets or sell them off for salvage value. With low capital costs and improved cash flow, the Company is likely to increase shareholder value significantly over the next several quarters.
- The OEM model will mean the Company will have lower margins than its peers during good times but will not be burdened by underutilized capacity during bad times. This model makes the Company less susceptible to the volatile nature of solar capacity cycles. This type of cost structure dramatically improves the odds of the Company's survival.
- During the transitionary period, as the Company moves to a pure OEM model, ReneSola's cashflow rather the GAAP earnings is likely to be a more meaningful indicator of the Company's shareholder value generation.
In light of the Company's poor cost structure and balance sheet, we have not been advocates of ReneSola in the past and believed that a strategic shift was essential for ongoing shareholder value creation. In this context, we applaud Company management for making the necessary strategic shift.
Here are our thoughts on the other, less strategic, aspects of the Company's conference call:What We Like About ReneSola:
- ReneSola's growing network of OEM partners makes it likely that the Company can effectively circumvent potential tariffs in the future - this reduces market uncertainty and makes the Company better positioned than its Chinese peers in adapting to varying regulatory dynamics around the world.
- ReneSola produced 1.816 metric tons of polysilicon in Q2 2014, which is slightly above its production level in Q4 2013. We find the small capacity growth somewhat disappointing. In light of the Company's extended maintenance shutdown in Q1, we were expecting the Company to have more meaningfully increased its capacity. Nevertheless, poly remains one of the brighter short term vectors for the Company. While ReneSola's fully loaded cost of polysilicon at $21 is not attractive, its cash cost of $17.50 makes this business a cashflow generator in the near term. ReneSola management also mentioned that the Company gets $1 to $2 dollars in subsidy from Sichuan government which brings its polysilicon cash costs down to the $15 to $16 range. With this updated cost structure, the polysilicon business is likely to be a significant cash flow generator for the next several quarters - possibly until 2016. With the benefit of subsidies, poly business alone is likely contribute a cashflow of around $0.08 to $0.10 per ADS per quarter for rest of 2014.
- ReneSola expects its total solar module shipments in Q3 to be in the range of 530 MW to 550 MW, and gross margin to be in the range of 15% to 17%. Both meaningful improvements from Q2 and can help the Company improve its balance sheet.
- The Company had indicated that it will be focusing on the "KW" DG market instead of the "MW" utility market. We believe the DG focus is prudent for the Company and in-line with OEM model.
- The Company continues to improve both its internal and external module cost structure. The external cost structure, which is a more meaningful metric to follow in the future, declined from $0.63 in Q1 to $0.60 in Q2.
- And finally ReneSola's inverter and LED lighting business continue to be wild cards. These businesses are nascent and gets barely a mention from the management. The inverter segment in specific should do exceptionally well in the context of the Company's DG focus.What We Do Not Like About ReneSola:
- The Company's profitability in Q2 was primarily a result of reversal of doubtful account allowance from Q1. The module business underperformed due to a decline of ASPs from $0.69 per watt in Q1 to $0.66 per watt in Q2 which was only partially offset by declining cost structure. Further ASP decreases in excess of cost reduction can adversely affect the Company's profitability.
- ReneSola's module cost may become higher without access to cheaper Taiwanese cell capacity. ReneSola is one of the few Chinese companies that can benefit from the cheaper Taiwanese cell prices. However, low Taiwanese cell pricing is a temporary phenomenon due to supply dislocation caused by US tariffs. It is doubtful if the low Taiwanese cell costs can be sustained for more than a quarter or two.
- While the Company's polysilicon operation contributed meaningfully to the positive cash flow, the polysilicon upside a short term story and it is doubtful if the Company can derive meaningful cash flows from this business past 2016.
- The Company's balance sheet remains one of the weakest among its Chinese peers. The debt situation severely limits the Company's strategic options including its ability to participate in the high margin solar project business.
All things considered, we believe the odds favor a solid 2014 for ReneSola and the Company is likely to exit 2014 a stronger and healthier company. Given the business model changes outlined by the company, we no longer believe the Company's survival is in question.
The asset light model is likely to be a winner in the DG market and we expect ReneSola to have a potentially strong 2015. While the near term results may be erratic due to industry dislocations from tariffs, polysilicon pricing, and other factors, we believe the Company is likely to enhance shareholder value in the near to mid-term.
ReneSola is a Company to watch as it executes on the new strategy.
Our Sentiment: Short Term Buy
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.