Solar's Impending Failures

Solar industry coverage in recent months has focused on the debacle at Solyndra and U.S. financing of the failed company. But we aren't the only country that has supported solar, as China has poured billions and billions of dollars into solar companies to build up the industry.

That support has helped push technology forward, lower costs, and, in an ironic twist, make many of the most heavily supported companies virtually insolvent. With a vast oversupply of polysilicon and solar modules for the foreseeable future, it's become apparent that China may have to let some of its solar companies fail. There's just no way the industry can support the current level of supply and losses these companies are posting and will probably continue to post.

Picking the losers
If China does let manufacturers fail, it will be those that have the most short-term debt and the worst financial performance. Normally, short-term debt is used to fund small items like payroll, but in the case of Chinese solar manufacturers it's been leveraged to build an entire industry. So which ones are going to be left standing when the music stops?

Let's look at seven Chinese solar manufacturers that have varying degrees of short- and long-term debt as well as cash levels. I've used second-quarter sales and gross margin as our proxy for ability to pay debts because growth rates vary dramatically across the industry, making trailing-12-month sales numbers less meaningful.

Source: Company earnings releases.

The analysis of this balance-sheet information is somewhat subjective, but I'll place companies into high-risk and lower-risk categories.

High risk
LDK Solar definitely tops the list of risky manufacturers, followed by Suntech Power and Hanwha SolarOne. These three each have heavy debt loads, not enough cash to cover debt, and very low margins.

The use of short-term debt to build manufacturing facilities has helped each of these companies expand rapidly over the past few years but could be their downfall going forward. Short-term debt can evaporate at almost any time, and if margins continue to be anemic, even the friendliest Chinese bank will turn its back on them. It's running out of cash like this that makes companies fail.

Risky, but not toxic
Trina Solar and Yingli Green Energy both have nearly enough cash to cover debt and double-digit margins, making them the safest of the companies in the table. After First Solar (Nasdaq: FSLR) and SunPower (Nasdaq: SPWRA), which are industry cost and efficiency leaders, respectively, I would consider Trina and Yingli the two least likely to fail in solar manufacturing (I know, not exactly a ringing endorsement).

JA Solar is a different story, because, instead of being a vertically integrated module manufacturer, it's mostly a cell manufacturer. When module demand falls in relation to supply, as it has this year, module manufacturers will use their own cells before looking outside for solar cells. That puts JA Solar in a tough position.

With all of that said, JA Solar has almost no short-term debt, potentially giving the company more time to wait out a market shakeout than its competitors. I'm not jumping into the shares today, but I would definitely say JA Solar has a better chance of surviving than LDK Solar and Hanwha SolarOne do.

Foolish bottom line
Evaluating risk is extremely important in solar right now as the industry deals with oversupply. I think many more bankruptcies are inevitable, and they may come from better-known names than Solyndra.

Now it's time for you to weigh in on which companies you think may be teetering on oblivion. Which Chinese company is most likely to fail?

• LDK Solar
• JA Solar
• Hanwha SolarOne
• Renesola
• Trina Solar
• Yingli Green Energy
• Suntech Power

Let us know in the comments section below.