Canadian Solar’s Q2 Projects Trouble Ahead for Chinese Companies

Things did not turn out that exciting after all for Canadian Solar investors, and unfortunately for the majority of the US-listed Chinese companies, the Canadian example tells us that things are bad and will be bad for a while

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There was a lot of hope and expectation among the investors’ community built on the Canadian Solar Inc. (NASDAQ: CSIQ) second-quarter results. Just to keep things in check the company warned about lower shipments prior to the release, yet the same announcement noted increased gross margins, which left the feeling that the company was still capable of delivering a positive outcome.  Certainly, nobody expected anything remotely as bad as the preannouncement offered by Trina Solar Limited (ADR)(NYSE: TSL), describing another unmet quarterly guidance.

Things did not turn out that exciting after all for Canadian Solar investors, and unfortunately for the majority of the US-listed Chinese companies, the Canadian example tells us that things are bad and will be bad for a while.  The future remains grim while they continue to hold to a manufacturing format as the only way to conduct the business. We have seen from the results of the American counterparts that companies running on the majority of EPC projects are capable of showing positive results. This may not be a permanent business solution, as nothing seems to have lasting stability in the solar industry, but it is nevertheless a solution for now.

The good news is that Canadian is probably the one that currently understands the process necessary to reach that EPC objective out of the entire Chinese lineup. Until the project money starts coming in, the manufacturing is just a money-losing exercise without stopping ASP from further deterioration. The other concern is that only a few can truly succeed in the EPC space. Not everyone is prepared, particularly financially, or is in possession of proper infrastructure to exercise top model results. China, as we read from reports written by Solarzoom’s own Dr.Tsai, is not doing well at all in the EPC project setting, and absolutely horribly in the manufacturing segment.  Even when projects are available there is the matter of time required to monetize them; time unfortunately is not on the side of the corporations. While perhaps not is all bad in the case of Canadian Solar, the second half of the year appears more and more as a period of continuing stagnation, instead of recovery.  

While Canadian Solar managed to dial up gross margins to a high of 12.4%, an improvement from 7.7% in Q1, the company still ended up losing money, on higher selling, general and administrative expenses and the foreign currency loss due to the Euro sinking against the Yuan. The loss was $25M, which translated to a negative $0.59 per share.

Larger shipments and an increase of shipping costs inflated the selling expense. Legal fees were indicated in part of G&A expenses; no amount was mentioned, but US levies costs were indicated as the factor. The gross margin lift contained a one-time benefit of recognition of the warranty insurance, a feature which contributed 4% to the margins’ increase.   Overall, a revenue of $348M was earned on 412MW of shipments, including 8.7MW coming from the company’s total solution business. Based on those details, the ASP of Canadian Solar landed in the vicinity of $0.81 per watt, which is about 9% less than the ASP from Q1.  During the conference call, Dr. Shawn Qu spoke of $0.67 per watt of costs, a reduction of six cents from the result of $0.73 in Q1. Apparently, the savings came from the solar wafer costs reduction shared with solar cell/module processing improvements. The wafer cost in Q1 was estimated at $0.31, which could easily have dropped to a range of $0.28 this quarter, the ASP level offered by GCL Poly already in Q1. However, the COGS per watt was at $0.74, a detail that confirms that those processing costs are referring to best lines, or are a result from current production metric, but not from the quarter.

From the perspective of the EPC projects, investors can look toward Q4 and 2013 for revenue recognition. The pipeline is quite impressive and includes 300MW in Canada, making Canadian Solar a dominant force in the Ontario market, and 140MW in the US. If we throw in the vague 150MW potential projects in China, the total of 590MW sounds really good, despite being dwarfed by the multi-gigawatts pipelines of the US companies. Moreover, Canadian Solar looks rather solid among its Chinese peers. Reading some of the analysis from Pierce Lee in China 2012 PV Installations Likely To Disappoint, the emerging picture casts a shadow on the immediate benefits of the Government’s target increase, assumed to be the saving grace for all project work in the Mainland. In light of this assertion, Canadian, with its international portfolio, positively stands out among the crowd.

Despite spending fewer dollars on R&D in the quarter, the company talked up the ELPS solar cell technology, and the recent accomplishment of 21.1% conversion for its mono-p type cell, giving an output of 280MW for a 60-cell module. Receiving successful feedback from customers, the company decided to convert some of its cell lines to ELPS capability and reach the capacity of 120MW by Q1 2013. Selective emitter and MWT (metal wrapped-through), which ELPS is in the latest version,  were planned to have capacity of 280MW as announced in 20-F this April, but we suspect the costs are still high, so the target was reduced. Dr. Qu did not talk about the Japanese module assembly plant, nor did he add clarity to the 700MW cell expansion.  Remaining uncommitted at this time of the year, the expansion will stay in a conceptual stage until 2013, in our opinion.

Things really got depressing when reviewing Q3. Since the company has halted some of the production in July, causing increases in processing costs and it will end up carrying a Q2 inventory to Q3 forcing impairment of value, gross margin will be lowered to the range of 2 to 5%.  The shipment guidance for Q3 was also set to a low of 420MW, while the full year was upheld with an objective of 1.8 to 2GW. In order to meet this guidance Canadian will have to deliver 825MW in shipments for Q4 to meet its higher end. This would be the largest quarterly shipment of modules in the history of the solar industry, something seemingly improbable under normal conditions, and especially doubtful in the environment Chinese-analysts called “gloomy.” Investors were suggested to observe the first revenue from EPC in Q4, in the amount of $100M. We see this as revenue and a potential gross margin boost; however, listening to Michael G. Potter, the CFO, we had the impression that this has a good chance to turn up in Q1 of 2013, so it should not be taken for granted.

Lastly, financially, Canadian had added $70M to its cash account, but also increased its borrowing by $141M in the quarter. The company had spent $70M to make a down payment on a $185M deal for 16 Ontario-based solar plant projects. In May the company obtained a $120M construction loan facility from Bank of China and on August 13^th, $93M from China Development Bank to partially finance the $185M acquisition from former SkyPower Limited, now called SkyPower Global. Canadian Solar’s overall debt stood at $1.064B, while cash and restricted cash account was at $692M. Despite the increase of debt, Canadian Solar looks relatively strong among some of the peers, which include financially hemorrhaging  LDK Solar Co., Ltd (ADR)(NYSE: LDK) and  cash-starved JinkoSolar Holding Co., Ltd.(NYSE: JKS)

Processing costs recently published by Canadina Solar did not make to this article at the time of the publication:

Wafer: $0.28, Cell: $0.17, Module: $0.22 = $0.67