Since the solar
downturn began in early 2011, barriers to industry consolidation have
been ever-present in the form of local Chinese officials being more
concerned with employment than rational lending practices. As leading
Chinese solar companies employ tens of thousands of people, access to
financing has continued unobstructed despite the fact that every solar
manufacturer in China is now hemorrhaging serious money. Companies that
should be going bust are still open for business because they're able to
burn cash by drawing down short-term debt. This in turn has led to huge
increases in leverage. It's not an exaggeration to say that Chinese
lending practices are single-handedly preventing the rationalization
that the solar industry so desperately needs.
A year and a half
into the solar downturn, unchecked leverage has ballooned to the point
where debt is now squeezing most if not all of the value out of equity
at the majority of solar companies. As we look across our solar
coverage, there are four companies where we believe this has occurred.
Three aren't particularly surprising: the financial problems of LDK
Solar LDK, Renewable Energy Corp. REC, and Suntech STP
are well-documented, and it will be hardly be a surprise if any of
these companies wipes out their equity base in order to restructure
their balance sheets. But we also believe cost leader Yingli Green
Energy YGE also
has also reached the point where its bloated debt burden has
effectively smothered out the value of its equity. For each of these
companies, our new fair value estimates are $0.
Yingli is almost
never mentioned as a firm with irreparable debt problems. But because
its net debt has increased by $1.5 billion in the last two-plus years,
we think this description is fitting. In our view, there is ample
evidence that the equity of one of the lowest-cost structures in solar
and the company with the highest market cap in China no longer holds any
shareholder value. Beyond its huge debt load, the reality is the solar
industry faces structural headwinds--massive cuts in subsidies,
cutthroat pricing in new growth markets, changes to business
models--which are likely to prevent margins from rebounding to anywhere
near predownturn levels. In such a scenario, Yingli won't come close to
generating sufficient cash flows from its business to justify its
current enterprise value. We think a debt restructuring is all but
unavoidable.
In our view, Trina Solar TSL
is the right way to play a potential upturn, provided that a bottom is
reached relatively soon. Operationally, Trina is almost the exact same
company as Yingli. The companies' production footprints and cost
structures are very similar, and their 2010-2011 EBITDA (excluding
charges) were roughly the same. What differentiates them are their
capital structures: Trina has $1.4 billion less net debt and interest
expense is running at half that of Yingli. To be sure, if the Chinese
government continues to prop up zombie solar companies for too much
longer--and it's impossible to know exactly when access to capital will
be sufficiently cut off--Trina could see its own equity value crowded
out by debt. But if consolidation happens sooner than later, we think
this is clearly the stock to bet on.
For First Solar FSLR,
margins won't be great, but enough to warrant a fair value estimate
increase. First Solar has fallen behind the lowest-cost Chinese
producers, but the company's technology looks likely to be able to
reduce costs faster than its peers during 2013-2016, especially when one
considers polysilicon prices (15%-20% of Tier One China's costs) are
likely to increase in the medium term. By 2015 we expect First Solar's
module costs will have fallen to $0.56, inclusive of an $0.08 efficiency
penalty, at which point we expect Tier 1 China to be at $0.59, assuming
$25 per kilogram silicon pricing. This is by no means a ringing
endorsement of First Solar, but it does suggest that it still has a
fighting chance to be one of the industry's long-term winners. We are
raising our fair value estimate to $37 to reflect our expectations that
the company will be able to generate profits (albeit at very slim
margins) once its pipeline of high-margin legacy projects runs out in
2015.
