The solar industry is a rapidly changing world of players that seem to go from darling to out of business in the blink of an eye. And for Canadian Solar (NASDAQ:CSIQ), one of the biggest solar manufacturers in the world, the challenge of getting strategy and financing correct in a highly competitive business is a tall order.
2017 is expected to be a fairly weak year in solar as subsidy changes in the U.S. and China throw the market for a bit of a loop. Long-term the industry has a bright future, and industry leaders should be able to build a profitable business. But Canadian Solar may not be setting itself up for the bright future others are in solar.
The business model transition solar companies are making
Canadian Solar is built like a company ready to dominate the solar industry in 2014. It's expecting to have over 7 GW of capacity by the end of the year (nearly 10% of global installations), has a 2.16 GW pipeline of projects it's building, and 1.16 GW of operating solar assets on the balance sheet that it values at $1.17 billion. It's set up for a time when solar companies were building as many of their own projects as they could, usually anticipating launching their own yieldcos.
But the model of solar manufacturers building solar projects has long passed. The margins associated with project development have dried up, and in some cases, projects are being sold at a loss. Developing projects is also a slow business cycle, which can put stress on the balance sheet of companies that don't have robust financial strength to begin with.
What solar companies like First Solar and SunPower are doing in 2017 is transitioning away from building projects to supplying complete solutions to developers. They don't just want to sell solar panels, they want to sell system design services along with panels, racking, inverters, and even energy storage. This is a higher turnover business that puts less stress on the balance sheet and potentially allows for more growth since capital can be invested in capacity expansion rather than building solar projects.
Canadian Solar hasn't yet transitioned to this component supply model, which I think will make more sense for solar companies long-term. It's holding onto solar projects and anticipates building more. And that's putting a lot of stress on an already stressed balance sheet.
The balance sheet nightmare
The problem with owning manufacturing capacity and solar projects is that it takes billions of dollars of capital to fund the business. That's why Canadian Solar has a balance sheet with $3.4 billion of debt right now.
But that debt hasn't built a profitable business, and in the first quarter, Canadian Solar actually lost $13.3 million. If a company can't make money after billions in investment, investors will eventually lose their patience and stop providing funding. That's how solar companies go bankrupt, and if Canadian Solar doesn't fix its operations and balance sheet soon it could be at risk of going bankrupt like Suntech Power, Q-Cells, and Solyndra before it (just to name a few).
The mistake Canadian Solar is making
What Canadian Solar should be doing is liquidating project assets that it can sell, including operational and pipeline assets, to slim down the balance sheet. From there it can focus on building a solar solution that solar developers will buy, rather than just selling solar panels. With its project development experience and massive capacity, it could be a major supplier for third party developers.
Selling more than 3 GW of solar assets could reduce the debt level to well below $2 billion, offset by $950 million in cash on the balance sheet. And with 7 GW of capacity, a net debt load of under $1 billion may be manageable, allowing Canadian Solar to build a profitable business. But right now it's a bloated company with assets it should unload and a business model that's spread too thin with too much leverage. Not adapting to where the opportunities are, and aren't, in solar could be a big mistake.