3 Red Flags to Watch for When Solar Stocks Report Earnings

Denver International Airport -- Source: NREL

Dawn has broken on another earnings season, and investors are itching to see how solar stocks have performed. While PV installations continue to rise -- not only in the U.S. but around the world -- it doesn't mean that this will translate to increased earnings for PV manufacturers -- the clouds may very well hang over their bottom lines. As measured by the two leading solar ETFs, Guggenheim Solar ETF and Market Vectors Solar Energy ETF, the solar industry has outperformed the S&P 500, but how will individual companies fare? Here are three important points to focus on as companies report.

TAN Chart

TAN data by YCharts

Location, location, location
First off, look for where the modules are going. Investors should seek companies that report deliveries to a variety of countries; heavy reliance on one country (or region) should be a warning sign -- especially China. The country started the year with an ambitious target of installing 14 MW by the end of 2014 -- 8 GW of which would come from distributed generation, but it recently hinted that the target may be unattainable as it struggles with credit availability.

Although it has established a target of 70 GW of installed capacity by 2017, it has not shown the type of growth that makes realizing that target a real possibility. Likely to be affected are companies like Trina Solar  (NYSE: TSL  ) , which delivered 34% of its modules to China in 2013 and forecasts deliveries of 30% in 2014. 

An area of concern for Chinese manufacturers is disproportionate reliance on deliveries to the U.S. With the Commerce Department raising the tariffs on Chinese PV modules, U.S. installers will likely shy away from importing these modules and look for more cost-effective solutions. According to GTM Research, in 2013, Chinese companies provided 31% of the modules installed in the U.S, but 2014 amounts may be much lower -- prices for Chinese imports are expected to rise between 7% and 20%.

Conversely, this may be a boon for U.S. suppliers such as First Solar  (NASDAQ: FSLR  ) , a leading supplier to the utility-scale market, and SunPower  (NASDAQ: SPWR  ) , a leading supplier to both residential and utility-scale markets.

A silver bullet through margins
As always, investors should focus on gross margins, and one factor that may significantly impact gross margins is the cost of silver -- an essential component of most PV modules. According to the Silver Institute, the solar industry accounted for 5% of global silver demand in 2013. Silver prices in the second quarter declined, and although it is not the only factor upon which gross margins depend, it is still important. Declining gross margins, in light of declining silver prices, should raise a red flag for investors as it may signify greater concerns in other manufacturing costs; furthermore, when silver prices rise again, these companies' gross margins may be hammered.

New York Silver Price Chart

New York Silver Price data by YCharts

For example, in the above chart, one notices a large decline in the price of silver throughout Q4 2013. For the same period, Canadian Solar  (NASDAQ: CSIQ  )  reported a gross margin of 19.5%. For the first quarter of 2014, the silver price rose, and Canadian Solar reported a decreased gross margin of 14.7%. For the second quarter, the price of silver is about the same, so a decline in the company's gross margin would be of concern.

Managing debt
One ever-present concern for PV manufacturers, especially Chinese, is the management of debt. 

TSL Debt to Equity Ratio (Quarterly) Chart

TSL Debt to Equity Ratio (Quarterly) data by YCharts

Trina Solar and Canadian Solar have done a good job at effectively managing their debt -- both companies have recorded improving debt-to-equity ratios over the past year; however, fellow Chinese manufacturer Yingli Green Energy (NYSE: YGE  )  has not been as fortunate despite other impressive metrics. Yingli, the leading global supplier of PV modules, recorded shipments in 2013 of 3,234.3 MW -- an increase of over 40% year over year. However, in light of Yingli's debt, the picture is a little cloudier. Its debt-to-equity ratio has skyrocketed over the past 12 months, suggesting that the company has risked too much in an attempt to deliver the most modules. 

The Foolish takeaway
There are a variety of issues to examine in evaluating a company's performance, but global distribution, gross margins, and debt-to-equity ratios are particularly telling when it comes to analyzing PV manufacturers. The above metrics should just be the starting point for any investor who is considering investment in this sector. 

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Scott Levine

A member of The Motley Fool since 2006, Scott began contributing content in 2013. He focuses primarily on the energy sector, specifically renewable energy companies. Follow him on Twitter for the most recent renewable energy news. . .

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