Solarfun Power Holdings CO., Ltd. ADS, Each Representing Five Ordinary Shares (MM)【SOLF】株式ニュース

Q2 Preview for Four Chinese Solar Module Producers
by: Investing Hobo July 16, 2010 | about: SOLF / STP / TSL / YGE

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In this second part, I'll be discussing four US listed Chinese solar module producers - TSL, STP, YGE, and SOLF; I won't be reviewing CSIQ because they are still under audit. Unlike their more upstream peers, module producers have more direct exposure to end markets which generally for the past several years has been to Europe. That's just a function of relatively better subsidies in Europe in recent years than other parts of the world. This is likely to change moving forward as costs continue to drop to levels where other markets outside of Europe open up with less or no subsidies, but at least for the remainder of this year, the majority of solar pv demand will still come from Europe.

With more direct end customer exposure, comes more direct exposure to the currencies they operate in. In the case with Europe or the EU, that translates to euro exposure. As a result, in the past several years, many of these solar module producers have seen wild currency translations both positive and negative. At times, the absolute numbers have been large as seen in the first quarter of 2010 where many companies posted net foreign exchange losses upwards to 25 million usd. With the euro depreciating over 9% during the second quarter, these losses will probably be even larger. So despite what are stable or better operating results, many of these companies will post large foreign exchange losses that will bring down net income by large percentages. Q2 will as a result probably mark the low quarter for these companies assuming there aren't as dramatic currency swings in the second half. The only except might be for solf who has generally been over hedged against the euro. In the first quarter for example, solf reported quite neutral currency translations while direct peers posted massive losses.

Obviously without proper hedging currency translations can affect reported results dramatically, but because currency can swing both directions such that over the course of time, the net effects are more neutral. That's the way many of these companies have approached the currency issue, and despite what were dramatic quarterly swings in currency in the prior couple of years, the overall net effect on annual earnings were more balanced.

There are positives to being a module producer with direct end market exposure however. Producing their own modules allows them to develop their own branding. It also gives them more control over their own business by not relying on downstream customers performing well. For example, a cell producer might be the best and most efficient cell producer in the world, but they will still rely on their customers who assemble modules to do well. If some downstream customers aren't properly managed, they may lose market share which in turn affects that cell producer. In addition, many module producers are more integrated as well. By cutting out the middle men within the value chain, they enjoy larger per watt gross margins on a normalized level. When prices are high, this is less apparent of an advantage, but when prices drop as they have after the credit crisis, margins on a per watt basis drop. For higher cost producers, there might not even be enough per watt gross margins available in the value chain for them to operate profitably as a corporate entity. This is the reason why fully integrated module producers have done better than single vertical peers in general. It's also the reason why more and more companies have looked to integrate beyond their main vertical.

Tsl is my favorite solar company among the group. It's generally been better managed such that during negative cycles as seen after the credit crisis, they avoided disastrous results. In fact, they were one of the few solar companies that grew during 2009, when many peers posted horrible losses. Their main advantage is their fully integrated business model, although recently they have added capacity beyond a fully integrated level. Through long term strategic planning, they are also highly centralized. As a result, they enjoy extremely favorable procurement costs, making them the lowest cost si-pv today. But as mentioned above, they will most likely post large foreign exchange losses for the second quarter. They also suffer slightly more because their functional currency is the usd, and much of their debt is in rmb. When the usd and rmb stayed stable in recent quarters, this wasn't and issue. With the recent announcement out of China which will probably indicate a rmb appreciation moving forward, tsl's rmb debt becomes larger relative to their usd functional currency. This results in foreign exchange losses which I estimate might be around 2-3m for the second quarter.

TSL Q2 2010

Revenues: 355m
Shipments: 215mw: 170mw full vertical, 45mw wafer outsourced
Asps: 1.65/watt
Unit Costs: 1.10/watt full vertical, 1.30/watt wafer outsourced
Gross Profit: 170 x .55 = 93.5m vertical, 45 x .35 = 15.75m wafer outsourced
Gross Margin: 93.5 + 15.75 = 109m / 355m = 30.7%
Operating Expenses: 31m
Net Interest Expense: 10m
Forex Loss: 23m
Tax: 7m
Net Income: 38m
Share Count: 79m
EPS: .48

Yge is another fully integrated module producer with a very strong brand name. In fact, they had a major advertising blitz during this year's World Cup to further boost their branding. In terms of capacity and shipments, they are the largest fully integrated si-pv company in the world currently, slightly larger than tsl; some companies have larger cell capacity but they are not fully integrated. Yge also has limited polysilicon capacity which they have yet to fully ramp. In terms of production costs, yge has been extremely efficient as well. Currently they are only slightly behind tsl, but I think in the next several quarters, they should be running neck to neck with tsl in terms of the lowest module unit costs. Like for tsl, yge will probably post large exchange losses which taint their second quarter. In addition, they were capacity constrained with new capacity not coming online until the end of last quarter; much of this new capacity is a new generation higher efficiency product which may be further accretive to earnings. Thus, sequentially, yge should post very large sequential shipment increases upwards of 50% for Q3. Without a major swing in currencies, this would translate to a dramatic increase in quarterly earnings. Q2 results will look lackluster, but they are far from a true measure of the type of earnings yge is able to produce from their capacity and cost structure.

YGE Q2 2010

Revenues: 360m
Shipments: 215mw
Asps: 1.66/watt
Unit Costs: 1.14/watt
Gross Profit: 215 x .52 = 112m
Gross Margin: 112m / 360m = 31.1%
Operating Expenses: 45m
Net Interest Expense: 13m
Forex Loss: 31m
Tax: 3m
Minority Interest: 4m
Net Income: 16m
Share Count: 154m
EPS: .10

Stp is the largest si-pv company by cell/module shipments. However they are not fully integrated and lack wafer capacity. Although they have investments upstream, they still rely on purchased wafers for their module production. As a result, part of the per watt gross margin goes to their wafer providers. As average selling prices fall, this puts more pressure on their own margins. It was less evident in the past, but has become more and more evident as asps continue to drop. Because asps will likely drop 6-7% in Q2 due to currency effects, while it's unlikely stp can reduce costs more than 5%, they will see per watt margin compression. Keep in mind I always use per watt gross margin because it's more important. Percentage gross margin may stay stable, but stable percentages on lower selling prices results in less gross profits. So despite higher volumes, stp will likely post lower gross profits in Q2. Stp also has downstream systems business, which for the past several quarters have apparently operated at negative margins. For the example I used below, I assume it will be neutral to margins. When combined with a potential large foreign exchange loss, it's also not out of the question stp could post a US GAAP loss for Q2.

STP Q2 2010

Revenues: 570m
Shipments: 325mw
Asps: 1.66/watt
Unit Costs: 1.35/watt
Gross Profit: 325 x .31 = 101m
Gross Margin: 101m / 570m = 17.7%
Operating Expenses: 50m
Net Interest Expense: 22m
Forex Loss: 27m
Tax: 1m
Minority Interest: 4m
Net Income: 5m
Share Count: 182m
EPS: .05

Solf is the smallest name among the four, but they are highly integrated and have decent cost structures. Their costs have not normalized yet so it's possible solf can still maintain the same level, or even higher level of profitability as selling prices continue to drop. One of the key difference between solf and others is that solf does more white label and oem business. The benefit is much less operating expenses, but the drawback is the reliance on those oem customers to perform. They also differ from others in that they have been over hedged against the euro. If this remains the case, their currency translations for the second quarter would likely be neutral as with the first quarter. This spares their reported Q2 numbers and on a relative basis, solf will look better as they report. When more capacity comes online in the second half, solf will also be operating on a fully integrated level. Right now, due to a number of reasons which include capacity constraints, procurement outsourcing, and contractual commitments, solf's costs are not what they should be at on a normalized level. Since there are so many possible factors which I'm not sure of myself, it makes predicting solf's numbers a bit harder. They appear to have some of their revenues at negative margins for example - if solf just operated on a more limited fully integrated capacity, their gross profits should be higher than stated. Also for the example I used, I assume solf will not post another inventory write down, since their costs have blended down to current purchasing costs by now.

SOLF Q2 2010:

Revenues: 214m
Shipments: 115mw module, 55mw oem tolling
Asps: 1.65/watt module, .45mw oem tolling
Unit Costs: 1.32/watt module, .40/watt oem tolling
Gross Profit: 115 x .33 = 38m + 55 x .05 = 2.5m
Gross Margin: 40.5m / 214m = 18.9%
Operating Expenses: 13m
Net Interest Expense: 6m
Derivative Gain: 2m
Tax: 3.5m
Net Income: 20m
Share Count: 58m
EPS: .34

The thing to keep in mind as these companies report their second quarter is that it's backwards looking. Because of potentially large currency losses, it's best to look more at their operating numbers and use that as a guide for the second half. If currency can stay stable, it's the operating results from Q2 that will translate to the bottom line for the second half. Unless market conditions materially change, operating profits in the second half should even be higher as shipments increase and selling prices stay fair stable with a more stable currency situation.

Disclosure: Long TSL, SOLF.. No position in YGE, STP.