My article on solar's inconvenient truth seems to have left readers angry, confused, or just hungry for more details. For the benefit of all camps, I'd like to follow up on a few of the ideas introduced yesterday. I promise to include more numbers this time.
Solar, by the numbers
Many of you want to see the numbers behind my cash flow concerns. There are a lot of ways to slice and dice the data, but let's try the following as a conversation-starter.
Below are the companies with the largest gaps between reported profits and cash flows in 2007, relative to sales. I would use trailing numbers that include the first quarter of 2008, but audited numbers from the Chinese solar players are slow to arrive. If you don't care about audited numbers, well, someday you will.
|
Company
|
Net Income ($millions)
|
Operating Cash Flow ($millions)
|
Gap as a % of Sales
|
|
Yingli Green Energy
|
56.7
|
(353.5)
|
69%
|
|
JA Solar (Nasdaq: JASO)
|
58.4
|
(167.2)
|
57%
|
|
Solarfun Power (Nasdaq: SOLF)
|
21.6
|
(146.6)
|
48%
|
|
LDK Solar (NYSE: LDK)
|
144.1
|
(80.7)
|
43%
|
|
Trina Solar (NYSE: TSL)
|
35.7
|
(59.5)
|
32%
|
Data provided by CapitalIQ.
The geographic concentration of this cash/profit chasm is notable, but China doesn't have an exclusive claim to the phenomenon. Plenty of other solar companies appear to have an earnings quality problem.
To be clear, this earnings/cash flow gap is a much bigger red flag for companies reporting profits rather than losses. I'd be more forgiving with Evergreen Solar (Nasdaq: ESLR), which reported a loss last year, because that company's just transitioning out of R&D mode. Ironically, Evergreen's GAAP net loss actually exceeded cash consumption last year.
Before we get to what this cash flow gap says about current and potential future financial stress, I want to reject the argument that it's normal or acceptable for firms to report profits while burning cash, so long as they're rapidly ramping up sales.
In a screen for additional companies reporting more than $20 million in earnings, a greater-than-$50 million cash burn, and more than 50% top-line growth in 2007, I can count the other non-financial/real estate firms on one hand. Furthermore, even within the solar space, First Solar (Nasdaq: FSLR) has shown that rapid sales, earnings, and cash flow growth can coexist harmoniously.
Where the rubber doesn't meet the road
Recall that operating cash flow does not include the massive capital expenditures that these fast-growing companies are incurring. So what are some reasons for the disparity between "profits" and actual cash hitting the corporate coffers?
One fairly straightforward issue is inventories. As the companies build capacity and race to supply a ravenous market, unsold raw materials and finished goods will naturally rise. Yingli, for example, hiked inventories about 55% as sales screamed upward by 148% last year. I'm not really concerned about shenanigans here, particularly since the LDK inventory flap turned out to be fluff.
Accounts receivable is a stickier matter. For Yingli, a company whose accounts receivable grew faster than revenue in 2007, turnover has slowed quite a bit -- from around 15 times in 2005 to around 10 times in 2006 and five times in 2007. ReneSola (NYSE: SOL) is another company that saw receivable growth outrun sales last year.
There's a real squeeze occurring here, and it's quite distinct from the industry's paucity of polysilicon. On the supplier end, Yingli notes that it's common industry practice to make advance payments to both polysilicon and equipment providers. Meanwhile, advance payment requirements imposed on Yingli's own customers have decreased. The combination puts this and other solar middlemen in a tight position before any goods change hands.
Slow cash collection is bad enough, but no collection would be a disaster. I've run out of time today, but in my next installment we'll look at the risks of anticipated cash flows failing to materialize.
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