Jinko Solar's Q1 2011 Earnings Continue to Top Expectations

Includes: JKS, LDK, SOL, TSL
by: Investing Hobo

Jinko Solar (NYSE:JKS) continued to impress investors with their recently released first quarter 2011 earnings report. Since their NYSE IPO almost exactly a year ago, the company has surpassed Wall Street earnings expectations in each of their four quarterly reports since becoming a public company. Jinko's Q1 2011 earnings were no exception as they posted 2.10 in earnings per share ("EPS") surpassing analyst consensus of 1.53 in EPS.

First quarter 2011 revenues climbed over 21% sequentially to $326.7m on increased total shipments of 208.4mw. Module shipments which will represent Jinko's core product moving forward increased to 166.6 mw from 111.6 mw recorded in the prior quarter. JKS's 49% sequential module shipment growth was extremely significant because it occurred in a seasonally weak quarter for the industry and amid policy uncertainties in key markets such as Germany and Italy.

In addition, overcapacity concerns in both the cell and module verticals have put pressure on lower tier providers. While both Renesola (NYSE:SOL) and LDK Solar (NYSE:LDK) are well established names in the industry, they are relatively new entrants in the module vertical. Due to the near term issues described above, both companies reported module shipment weakness in the first quarter of 2011. LDK lowered their Q1 module shipment expectations to 109-114mw from a prior guidance of 120-140mw. SOL which reported earnings last week posted module shipments of 86.9mw, well below their 100mw approximation given in their Q4 2010 conference call.

What JKS, SOL, and LDK all have in common is that they are all new entrants in the module vertical with each only having around a year of experience. In other words, they are generally regarded as secondary tier providers who are more vulnerable to demand weakness than first tier counterparts. How then was Jinko able to gain market share, albeit off a smaller base, when more well known companies like LDK and SOL experienced weakness?

Whether Jinko Solar made the transition from new entrant to tier one provider remains in question. To be certain, the company has made great progress in establishing relations with higher tier customers. This may be explained with their talent acquisition of Arturo Herrero in January of last year. Mr. Herrero served as Trina Solar's (NYSE:TSL) head sales and marketing executive since prior to their own IPO in late 2006. He may also be in part one of the main reasons why TSL was able to gain tremendous market share from very low levels and against much larger entrenched peers. After leaving TSL for JKS, Mr. Herrero may have brought all his experience in developing contacts with key industry participants such as Enfinity and IBC who quickly became Jinko customers. Trina Solar has not brought any action towards Jinko Solar nor Mr. Herrero, but in JKS's SEC filings did warn of potential legal risks over non-compete covenants.

Jinko's second quarter module shipment guidance is equally impressive as their first quarter sequential growth. For the current quarter, the company expects module shipments to range between 190-200mw, up from 166.6mw reported in the first quarter. Much like the first quarter, continued sequential volume growth is extremely impressive in what appears to be an oversupplied market as suggested by recent spot market average selling price ("asp") declines. Typically in oversupplied environments lower tier providers would have the most trouble placing their products.

Due to bankability issues, some lower tier companies simply may not be able to place their products at all if banks financing solar projects consider them a higher risk. JKS appears to have bankability addressed as well with a recent banking road show as described in their Q1 2011 conference call. According to the company, the number of global banks financing Jinko's modules increased from 20 banks at the end of 2010 to 25 banks at the end of the first quarter 2011. However JKS has been pitching themselves, it appears to be working given their continued sequential volume growth even during more challenging market environments.

Structurally, Jinko Solar is very much like Trina Solar and Yingli Green Energy (NYSE:YGE) in that it is a fully vertically integrated crystalline module producer. Also much like TSL, Jinko started off as an upstream wafer supplier and migrated downstream to become a fully integrated module supplier since early last year. As a result, JKS can eliminate several middlemen and enjoy most of the gross profits among the value chain themselves. In addition and similar to TSL, Jinko recently announced horizontal expansion in other various material component production used in module assembly, such as aluminum frames and junction boxes; Trina Solar does differ slightly in that they horizontally integrate through a virtual process by having co-location component suppliers as strategic partners.

For the first quarter of 2011, JKS's non-silicon processing costs came in at a very impressive .73/watt, down from .75/watt posted in the prior quarter. On a relative basis, their processing costs are directly comparable to industry leaders such as TSL and YGE. Jinko hopes to further reduce this metric to .67/watt by the end of 2011 through a series of measures including larger scale, more diverse suppliers and horizontal integration as described above. If the company can achieve this benchmark, Jinko would rank as one of the global leaders in processing efficiency which is a key metric in determining corporate profitability.

Unlike many tier one peers, Jinko Solar elected not to secure long term polysilicon supplies. It is a controversial decision given the historical shortage of polysilicon for most of the past eight years. Jinko's rationale is that by being fully integrated and thus cost efficient, the company can absorb short term polysilicon price hikes. In part, this logic has been correct and despite recent polysilicon price increases from $50/kg to over $85/kg in recent quarters, JKS has still been able to maintain a fully integrated core module gross margin above 30%. However, such a strategy does leave the company vulnerable to special circumstances where the pricing spread between polysilicon prices and module asps narrow enough to collapse profit margins completely.

In addition, JKS's management also argued that securing large, long term polysilicon contracts would have required large sums of upfront prepayments, which could cost well over $100m. Given the company's stretched balance sheet, where total debt liabilities exceeded cash equivalents by over 130m in the most recent quarter as well as the company's recent quarterly working capital deficit, the decision to forego long term polysilicon contracts may have been more of necessity than choice.

Still, this gamble may pay off if Jinko can continue to win market share by quickly increasing shipment volume. Valuable capital not spent on procurement prepayments has been used to expand capacity rather aggressively. In just a little over a year, JKS has been able to build cell and module capacity from scratch to 1gw while expanding their wafer capacity to meet their full vertical integration goals. Many direct peers operating for over four years have not been able to achieve such a magnitude of capital expansion. If all of Jinko's new capacity can be fully utilized, absolute shipment growth could outweigh gross margin lost by higher polysilicon procurement costs. At least since Jinko's IPO last year, the company has been able to increase gross profits sequentially in each and every quarter.

According to metrics presented by JKS in their Q1 2011 conference call, as well as their official Q2 2011 guidance of 190-200mw in module shipments and $330-350m in revenues, Jinko could enjoy another quarter of sequential gross profit growth. As usual, for all my quarterly estimates I try to keep metrics within official guidance unless implied company comments suggest otherwise. Below is an estimate for what Jinko Solar's second quarter 2011 earnings may resemble.

JKS Q2 2011 Earnings Estimate:

Revenues: $344m
Shipments: 205mw module, 15mw wafer
Asps: $1.62/watt module, $.80/watt wafer
Module Unit Cost: $1.17/watt
Gross Profit: 205mw x $.45/watt = $92.3m
Gross Margin: 26.8%
Operating Expenses: $23m
Net Interest Expense: $6m
Tax: $9.5m
Net Income: $53.8m
Diluted Share Count: 24.5m
EPS: 2.20
Potential Foreign Exchange Loss: $4m
Potential Foreign Exchange EPS Impact: .16

The 2.20 EPS estimate above are operational earnings, which exclude currency translations as well as any unannounced charges. The $4m of net foreign exchange loss is an estimate based on recent USD/euro exchange rates of 1.48. With almost two months left in the quarter, actual foreign exchange gains or losses remains a moving target. Current foreign exchange translations also assume the company maintains the same level of exposure as in the prior quarter. Without direct insight into how a company hedges their currency exposure, any currency translation estimate carries a high degree of error and should only be used as a rough guideline.

As well as Jinko Solar has executed as a company since their IPO last year, the company is still a relatively new entrant in their core module business. JKS has both a very limited operating history as a public company as well as a module supplier. As a result, the company should be view in a higher risk uncertainty category than direct first tier Chinese peers such as Trina Solar, Yingli Green Energy, and Suntech Power (NYSE:STP).

Although the company has been extremely successful in promoting and branding themselves as evident in their continued strong shipment growth, Jinko's accounts receivables did increase substantially in the most recent quarter from $87m to over $200m. If JKS's volume growth came at the expense of credit terms or customer quality, then their recent growth pattern may be unsustainable and could result in potential issues down the road. This is far from a red flag given the company's shipment growth, but it's definitely a metric to keep an eye on in future quarters.

Lastly, as indicated, Jinko has an extremely stretched balance sheet despite a secondary public offering completed in November of 2010. Although the company's projected operational cash flow in 2011, in addition to their credit lines, could cover their $350m in 2011 capital expenditures, JKS may elect to seek additional financing through the equity markets in order to avoid further increases in their debt ratio. While additional secondaries are not bad in themselves, they may increase volatility in the company's share price as well as cause dilution if the capital raised is misallocated.

It is possible these concerns may already be reflected in JKS's stock price. After Jinko's Q1 2011 earnings, their trailing EPS stood slightly above 7.50. At a recent share price of under $26, JKS's trailing price to earnings ratio is under 4x which is extremely low given the company's growth rate. If the company can continue to execute as already shown in the past several quarters, Jinko Solar may emerge as a dominate first tier player in the solar industry within another year.

Disclosure: I am long JKS, LDK, TSL, YGE. No position in SOL, STP.