Impending Solar Shakeout

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Includes: CSIQ, JKS, RUN, SPWR, SUNEQ, TOT, TSLA, VSLR
by: Bravo Family Fund

Summary

The solar sector has had a challenging few years.

A solar shakeout is on the horizon.

Companies are moving to a new business model of "build and sell."

The solar industry has been in a downtrend since 2015 due to overcapacity and commoditization. The average selling price for solar products is falling sharply. There are no clear-cut winners in the solar industry.

In the past, companies that had a short winning streak had focused on the development of utility scale projects, with a subsequent dropdown of the projects to yieldcos. This business model involved taking on heavy debt to invest in these projects, which served as collateral and provided the cash flow via power purchase agreements.

SunEdison's (OTCPK:SUNEQ) bankruptcy exposed the flaw in this business model. Companies chased projects at ever-decreasing margins to achieve the scale. Large project backlog was supposed to serve as the monopoly. Rapid project backlog was used as a justification for capacity expansion. Poor performance of the yieldcos led to rising cost of capital and interest expense. Companies had ever-worsening balance sheets associated with capacity expansion and project debt. This eventually led to the demise of SunEdison.

Another challenge for the solar industry is the rapidly changing solar technology. For example, there's the recent increasing demand for high-efficiency solar panels. Even Chinese solar companies are moving toward higher efficiency mono-silicon or mono-PERC cells.

Canadian Solar (NASDAQ:CSIQ) and JinkoSolar (NYSE:JKS) are spending capital to expand their mono-PERC capacity. They hope to capitalize on higher margins of these modules to offset falling margins on poly silicon modules. SunPower (NASDAQ:SPWR) has invested its capital into high-efficiency X-Series panels. They will build 5 GW of P-Series manufacturing in China. First Solar (NASDAQ:FSLR) has skipped the transition from its Series 4 platform to the Series 5 platform. The Series 6 module will have an efficiency of over 18%, while its peak power generating capacity will be over 420 watts -- as compared to 365-390 watts for Series 5.

The emergence of these new technologies means large capital investments to upgrade to new technologies. For those who think this might be a one-time expense, they are in for disappointment. The technology cycle will likely upgrade again in two to three years. Investors are in for a rude awakening in the form of poor returns by rooting for these solar companies. Some of them might not survive beyond 2018.

Amid all these disappointments, companies are trying a new business model. Other than ownership in the project, the companies will do everything from bidding for the project to the design and construction of the project. SunPower and ReneSola (NYSE:SOL) have been pioneers in this direction. JinkoSolar and Canadian Solar are evolving into this direction albeit at a much slower pace.

Another change in the direction of this business is moving away from the large-scale utility projects to the DG (distributed general) projects. Overall, the utility scale power plant development is in a declining phase. The DG market offers far more opportunity. SunPower and ReneSola are doing a good job of capitalizing on DG growth. DG provides a good balance between maintaining the margins and not paying too much for the customer acquisition. ReneSola's distributed generation pipeline is about 393 MW.

Residential solar companies -- such as Tesla (NASDAQ:TSLA), Vivint Solar (NYSE:VSLR), and Sunrun (NASDAQ:RUN) -- have a customer acquisition cost that is too high. Therefore, the growth in the residential market is not likely to create enough moat for these companies to provide a steady stream of profits. Canadian Solar and JinkoSolar are still focused on inventory management and module sales arrangements. The primary reason for that is their large capacity and, thus, revenue dependence on module sales.

SunPower, which has moved on to the path of build and sell, has their own problems with debt. The liabilities payable in 2017 and 2018 are around $900M each year. Total (NYSE:TOT), 57% majority owner of SunPower, has been supporting the company. But the debt load is too heavy, and there might not be much left for the remaining shareholders once the dust settles.

ReneSola is a much smaller company with extremely small capacity that is trying to completely transform into a service company, from a legacy wafer manufacturing company. It hopes to enjoy the benefits of new technology and declining costs without any capacity expansions. It has focused on project development while milking its legacy wafer manufacturing business. It now has one gigawatt of projects in various stages of development. The shovel-ready pipeline features 428 megawatts in the U.S., the UK, Turkey, China, Japan, Canada and France. In China, where margins on utility scale projects are low, they have focused on DG project development.

But ReneSola has its own debt problem; it relies on short-term debt. Total debt stands at $699 million. Cash and equivalents, including the restricted cash, was $139.4 million at the end of Q3 2016.

Conclusion

After the shakeout, there will be very few survivors in the solar industry. Canadian Solar and JinkoSolar might survive given the sheer scale and diversity of their businesses. First Solar does not have much debt, so it should survive the downturn and changes in the solar business. ReneSola, being a smaller player with the ability to rapidly change its business model, will also survive this downturn. SunPower will not make enough money to pay its debt come 2018.

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.

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