TUESDAY, AUGUST 30, 2011
Solar May Start Seeing a Bottom
A drop in polysilicon prices soon is the first step, says Credit Suisse.
Solar stocks have neared the one times enterprise value (EV)/replacement value of capacity we have long argued as downside to the space, and there could well be a bounce trade into PV-SEC conference in Germany next week.
However, in this report we present several charts that highlight the excessive lending by Chinese banks to the solar industry, which is prolonging the necessary correction in fundamentals for the industry.
The longer and larger the Chinese bank-lending bubble for solar inflates, the sharper and more unpredictable will the eventual fundamental correction be due to industry consolidation.
A prolonged bubble could result in a worst-case scenario eventually that involves fire-sale prices driven by widespread inventory liquidation by companies forced to exit the business. We expect the lending spigot will tighten soon, and lead to production cuts for wafers and cells.
We will first observe the symptoms of that in the form of rapidly declining polysilicon prices. A trough in polysilicon prices is a prerequisite to call the bottom for the sector, and if not for the lending bubble, polysilicon prices could be a lot lower already.
How big is the bubble? Net debt for the U.S.-listed solar companies (about 50% of total industry volumes in 2010) has ballooned from $2.0 billion in the fourth quarter of 2010 to $6.2 billion by the end of the second quarter of 2011.
Gross debt has increased from $10.4 billion to $14.8 billion from the fourth quarter of 2010 to the second quarter of 2011 — an increase of $4.4 billion.
A vast majority of the debt financing is coming from Chinese banks in the form of short- and long-term loans. The capital has been used for increasing working capital and for capital expenditure.
This excess financing has resulted in artificially higher demand for equipment and polysilicon — investors need to distinguish the effect of lending on demand versus sell through on demand.
There is evidence to suggest that end demand has not kept pace with the rate of production in the first half of 2011, and our report today also adds evidence that bank lending is inflating demand for polysilicon from mid-stream companies at the expense of high inventories. There is also an incentive for polysilicon companies to manage the prices higher, as most contracts are tied to spot market prices as well.
For Chinese companies listed in the U.S., working capital (defined as receivables plus inventories less payables), has increased from $2.9 billion at the end of the fourth quarter of 2010 to $4.4 billion at the end of second-quarter 2011.
Capital investments by U.S.-listed Chinese companies have increased to $1.8 billion in the first-half of 2011, the highest levels in any two-quarter period for the industry.
The generous access to debt is being used by China solar companies to achieve economies of scale, offer extended credit terms to customers to augment their already industry-leading cost positions to gain share in the solar industry.
Will this bubble burst? We are already seeing production cuts happening for LDK Solar(ticker: LDK), ReneSola (SOL), JA Solar Holdings (JASO) and for European companies like Q-cells [of Germany] and Renewable Energy Corp. [of Norway], so there are signs that finally access to capital is starting to become an issue. JinkoSolar Holding (JKS) recently increased long-term debt, partly due to worries of tighter access and higher cost for short term debt.
However, we are yet to see the tightening credit manifest in the form of cuts to polysilicon production or downside to polysilicon prices. We need much sharper production cuts, which will only happen when the debt bubble bursts.
We expect the debt bubble will burst in the next six months, as debt/earnings before interest, taxes, depreciation and amortization (Ebitda) has spiked up from 1.5 times in the fourth quarter of 2010 to 6.1 times in the second-quarter of 2011.
The short-term debt has no covenants for Trina Solar (TSL) for example, but needs to be renewed each year. Long term debt for Trina Solar has covenants like debt-to-asset ratio, return on equity and income to net interest ratio. Certain loan agreements forYingli Green Energy Holding (YGE) have debt/Ebitda covenants.
We prefer to see a sharp cut in polysilicon prices soon to start the bottoming process for solar.
Once polysilicon bottoms, First Solar (FSLR) will be a name that will generate more interest, as incremental downside risk will be low from China competition.
However, no stock, First Solar included, is immune from a prolonged period of excess production due to irrational lending and the resulting unwind of inventory/production.
Thus, polysilicon prices remain a key metric to watch, we reiterate our $25 per kilogram (kg) view for polysilicon spot prices by year-end.
— Satya Kumar
— Brandon Heiken