We've seen the beginning of solar failures, but over the next year there will be more companies that bite the dust as the industry deals with oversupply. In the first round, Chinese companies drove higher-cost, less nimble competitors from the market by expanding supply and driving down cost.
But this has created its own set of problems in China. Government-owned banks handing billions of dollars to solar companies funded the fast expansion in capacity and forced out U.S. and European competitors. But now these companies are having struggles of their own as margins have been crushed and losses pile up.
The situation isn't going to improve anytime soon, either. GTM Research says module capacity was double global installations last year and there will continue to be structural overcapacity even if plants are retired in the coming years.
China will pick winners and losers
This leaves China with some choices in the solar market. It can continue to bleed red ink, allowing weaker companies to survive, or let some manufacturers fail and consolidate the best assets with the best companies. How and when China does this is the million-dollar question.
It isn't hard to see companies that should probably be let go now. LDK Solar, Hanwha SolarOne, and ReneSola (NYSE: SOL ) have negative gross margins and are watching operating conditions get worse nearly every quarter. Their balance sheets also continue to deteriorate with no end in sight.
Gross Margin (Most Recent Quarter)
|JA Solar||0.5%||$632.0 million||$84.2 million||$887.4 million|
|Hanwha SolarOne||(20.1%)*||$358.8 million||$280.3 million||$332.6 million|
|ReneSola||(3.8%)||$388.3 million||$662.6 million||$249.8 million|
|Trina Solar (NYSE: TSL )||7.1%||$896.4 million||$389.5 million||$647.9 million|
|Suntech Power (NYSE: STP )||9.9%||$709.0 million||$1,562.4 million||$742.1 million|
|Yingli Green Energy (NYSE: YGE )||3%||$891.9 million||$1,326.9 million||$930.8 million|
|LDK Solar||(10.1%)*||$809.1 million||$2,216 million||$1,131.7 million|
|JinkoSolar||(4.4%)||$170.7 million||$659.3 million||$24.7 million|
|Canadian Solar||7.7%||$625.2 million||$861.9 million||$89.3 million|
Note: Gross margin excludes one-time items.
Even relatively strong manufacturers are probably going to have some sort of debt restructuring. Suntech Power has $2.3 billion in debt and won't be able to sustain it unless there's an unforeseen turnaround in the business. Yingli Green Energy is considered a top-tier supplier, but that company is seeing margins fall, with debt starting to look like an anchor on its future.
Trina Solar and Canadian Solar are the only two in our table that may be able to handle their debt as the market improves, because they've managed to maintain high cash levels.
What will China do?
I can't imagine that China would keep all of these companies alive, with the losses they're putting up. Even the Chinese government wants a good return on its investment. But how the country will restructure its investment is still unknown.
There is something of a precedent in polysilicon, where 43 companies have been quickly whittled down to about eight as manufacturers have closed up shop. The government was essentially forced to let some companies fail instead of using mergers and acquisitions to consolidate them. Will that happen with module manufacturers, too? I think at least a few companies will just vanish.
The big question comes with companies like Suntech and Yingli, which are decent operators but have more than $1 billion in short-term debt and $2 billion in overall debt. Judging by the hearsay at last week's GTM Solar Summit, the expectation is that some debt will be converted into equity at the stronger manufacturers. This may not leave current shareholders with a lot of value in the end.
It's risky business
Betting on Chinese solar manufacturers is risky business, primarily because we don't know what the Chinese government will do with them. The loans the country has provided is keeping some of these companies alive right now, but soon that won't be the case. There are just too many losses and too much supply for the status quo to continue.
I think Canadian Solar and Trina Solar are the two best bets to come out alive, and LDK Solar and ReneSola are two of the worst bets. However, if you're unsure of the solar market and need a great energy stock to add to your portfolio, check out our free report highlighting a top-notch energy stock for any market. This detailed report is free for a limited time.