ReneSola (NYSE:SOL) has seen its stock price remain close to its 52-week low for most of the past year. It currently trades at value suggesting that it's at a risk of bankruptcy. However, this could not be further from the truth. In fact, ReneSola has turned around and become one of the few profitable Chinese solar companies. It should command much higher value going forward in 2016-17.
ReneSola never recovered its market cap, even after the company repurchased all of its convertible notes due March 15, 2018, upon exercise by note holders of the put option in March 2016. Part of the reason for the depressed value is due to the general negative investor sentiment toward solar sector and recent bankruptcy filings of Sun Edison (OTCPK:SUNEQ). Shareholders never returned to the company after the liquidity concerns alleviated after this convertible bond purchase.
We think it's a good time to buy the shares in this great company at rock-bottom prices. ReneSola is undervalued even more than its Chinese solar peers. The company has stabilized, and it is a great turnaround story going forward.
The Solar Industry
Before we start discussing ReneSola in any detail, we need to look at the solar industry as a business first. The solar industry has underperformed the general market in most years. General perception is that solar stocks are a risky investment.
This perception exists for a reason, as the solar industry is poorly regulated and a fiercely competitive business. Competitive advantage in the solar industry is becoming more elusive by the day. Even size does not matter in the solar industry, as made evident by Sun Edison's situation.
The solar industry is plagued by overcapacity and trade wars. There has been rapid expansion in production capacity over the last five years. This has been made possible through easy capital and subsidies provided by the government. The high cost structure and the trade wars in a rapidly changing regulatory environment portend disaster. There are many companies that have succumbed to this challenging environment, such as LDK solar, SunEdison, etc.
The solar industry's demand for capital seems to be insatiable, so much so that even the massive growth in the overall sector is not reassuring. Capital expenditures justified by pure spreadsheet calculations that are projecting profits into the future are uncertain, as made evident by the failing yeildco markets. But that does not mean that a good return is not possible in this high risk sector. It will require some understanding and risk taking to find good bargains in the industry.
The core of ReneSola's transformation is evident in its downstream project development. Downstream projects are the only things close to a "competitive advantage" in the solar business at this time. There is substantial opportunity worldwide. ReneSola has started to establish itself geographically around the world as a downstream renewable project developer.
It has successfully developed and sold projects in the U.K. and Japan in a short period of only 1.5 years. The company has already sold 71 megawatts in the U.K. and 1.8 megawatts in Japan. There are 54 megawatts under construction in the U.K. and 29 megawatts in Japan, which is expected to be completed and to connect during 2016. There are 5 megawatts under construction in Canada. Beyond the 88 megawatts under construction, the company has announced 553 megawatts of potential pipeline of projects around the world.
ReneSola is avoiding development of projects in China and India. Although both of these markets are quite large, the margins are rather small. The rules for FIT payments for these markets are less certain. All of this gives ReneSola a stable cash flow for near future. These projects will help establish stable cash flow and pay down some of its debt.
Build and Transfer model
ReneSola is pursuing the build and transfer model, and over time it expects to sell the entire pipeline. This is in line with their promise of higher profitability and a stable cash flow for the company.
ReneSola's peers raise capital for expenditures justified by projected profit calculations and secured by using project assets. But the promise of income into the future is highly uncertain, as evidenced by the failing faith in yeildco markets. ReneSola's approach to cash out on projects and enhance the enterprise value in short run seems to be a safer approach when compared to its peers.
ReneSola is looking beyond solar-related business. The company is expanding into a new LED distribution business. It has shown 35% quarter-over-quarter growth in revenues in this new segment over the last two quarters. The company projects it will continue with the same growth rate.
LED lighting is a growing market. This market will expand substantially, as energy efficiency retrofit growth becomes a trend around the world. Company projects to deliver 30% to 50% sequential growth in LED revenues in 2016. Gross margins are at 30% for this new line of business.
Some have suggested that ReneSola should divest from the LED business. I would disagree with that suggestion. The company's presentations suggest they have no such plans. This can be an exciting new opportunity for ReneSola. It has a potential to provide exponential growth over the medium to long term. There were over 3,270 customers who purchased LED products from ReneSola at the end of 2015. These numbers appear small, but could have a larger impact on the company's outcome than is evident at this time.
ReneSola, or any other solar company, has a very small chance of building a sustainable competitive advantage in the downstream solar business. But the LED distribution business is different from the solar business. This can be a skeleton for B2B distribution network. The revenues from the LED business are small compared to the solar project business, but these customers have a high lifetime value as compared to the downstream solar business.
As such, the B2B network has to be valued on different metric than the solar business. If ReneSola is able to build this B2B distribution network with LED serving as a skeleton and adding products, growing revenue exponentially and turning it to a B2B platform will take much less effort and time. This network in itself will become a robust competitive advantage over time.
Debt, Profit and Loss
The company has continuously improved its quarterly gross margin and expects the gross margin around 17% for the first quarter of 2016. For the full year, they expect revenue in the range of $1 billion to $1.2 billion. Increasing focus on the downstream going forward will return net profits and substantial cash flow for 2016.
The company's gross margin is likely going to be better than its peers, such as Canadian solar (NASDAQ:CSIQ), JA Solar (NASDAQ:JASO), and Jinko Solar (NYSE:JKS). Canadian Solar had a gross margin of less than 16% for Q1 2016. Polysilicon plants will likely further help ReneSola deliver better gross margins when compared to its peers in 2016, due to increasing polysilicon costs for its peers.
ReneSola has decreased its operating expenses from $33.9M compared to $46.2M just a quarter prior. While debt still remains a big issue for ReneSola, total debt stands at $707.6 M as of December 2015. The company reduced the debt by a small amount of $16.8 millions during 2015. Although the debt reduction was small, it was the first step in the right direction. That's especially true considering 2015 was the first year when ReneSola started to turn around.
The company will generate $100M-plus of free cash flow from its business in 2016, based on the guidance given during the conference call for Q4 2015. The question of debt of $707.6 million still remains. Any investor who invests in ReneSola would like to know how the company plans to pay the debt off, as well as provide a reasonable rate of return for the investors. There are a few different ways to look at this debt and capital layout of the company.
Like any manufacturing business, ReneSola has debt used to purchase equipment and plants. The debt is not out of proportion if you consider the revenues for the last few years. The drag on the value of the business is related to overall doubt about the longevity of the solar business and the sustainable nature of the company's recently profitable quarters.
There is an art to evaluating those questions. There are a few things that are reassuring about the debt situation. One is the massive growth in the solar sector, which will keep providing ongoing opportunities for the company. The massive growth can be considered a reasonable reason to trust the longevity question of the solar business itself. The company has shown that it can adapt and change rapidly along with changes in the industry. It has evolved from a wafer manufacturer to a downstream solar developer during some tough times. There is very little doubt that it will evolve with the evolving nature of the solar business.
Management owns a majority stake in the company and has been buying back shares to increase shareholder value. This also shows confidence in their ability to pay off the debt and the interest in the short to medium term. The survival aspect of the business is argued on the basis of the project pipeline extending out four to seven years, depending on the speed at which the company builds the projects. That time frame should provide the company an opportunity to consolidate its debt situation, by paying of significant debt from the free cash flow it will generate from the downstream business. Also, that time frame will provide the opportunity for the company to find other growth areas, in particular the B2B LED platform the company is working with currently.
The company has not raised capital recently, and has stated that it will keep working on improving the balance sheet over that time frame. If investors can share management's vision of debt reduction and trust their ability to build the B2B LED platform, an argument can be made about a significant increase in shareholder value in the next four to seven years.
Risks and Final Thoughts
ReneSola has not only successfully transformed into a downstream solar company, but has also successfully tested its strategy to diversify into other growth opportunities. It has been able to reduce debt and buy back convertible bonds, and has recently turned profitable. Currently, the debt does drag on the valuation of the company, but there is a reasonable chance that that will also become a thing of the past.
The picture will become even clearer once the company releases its Q1 results on May 23, 2016. Things to watch for in this report include improvements in gross margin and growth in the LED segment.
Disclosure: I am/we are long SOL.
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.