China’s Bad Loans Signal Problems for Solar

The economic slowdown in China has hit the banking sector, as several Chinese banks show concern over a possible increase in non-performing loans. There is also fear that diminishing investment will also lead to a decrease in consumption. And the signs are there – according to a survey by the National Bureau of Statistics, disposable per capita income for urban dwellers grew 9% in the first two quarters of 2013 compared to an average of 13% reported for the last five years.

To sustain the rapid economic growth, China's banks expanded their lending and were rewarded with annual profits of more than 20%. Now several industries, particularly solar energy companies, find themselves with too much debt. Their expanded operations have led to excess capacity amid decreasing sales. I'll examine the financials of three of the top solar energy companies in China to examine how they're managing their debt levels.

Suntech Power Holdings
The largest solar panel maker in China, Suntech Power Holdings (STP) provides products for residential and commercial uses. It has delivered over 25 million solar panels to over 1,000 customers in more than 80 countries. The company showed in its 2011 annual report increasing capital expenditures by as much as 93% from 2009 to 2010. Short-term borrowings and current liabilities have also been rising since 2007:

Source: Suntech Power 2011 Annual Report

From 2009 to 2011, the company financed its operations mostly through short-term and long-term bank debt. In addition, by the end of 2011, Suntech did not meet the financial covenants in all of its long-term commercial bank loans, which carried a total principal amount of $40 million. Of those loans, $27.9 million were reclassified from long-term to short-term borrowings due to the non-compliance.

Suntech delayed the filing of its 2012 annual report as the company and its largest subsidiary, Wuxi Suntech, undergo restructuring to improve their balance sheets and cost structures. Preliminary results for the fourth quarter ended December 31, 2012 showed a decline in revenues of 8% and gross margin was about .4%. 

LDK Solar
Another player in the solar power industry is LDK Solar (NYSE: LDK), an industry leader involved in photovoltaic, or PV, manufacturing and project development activities. In its 2012 annual report for the period ended December 31, LDK Solar showed how its working capital deficits have increased -- $3.1 million in 2012; $2.1 million in 2011; and $1.6 million in 2010. There was also mention of "substantial doubt" of the company's ability to continue operating. LDK Solar had a net loss for 2012 of $1.1 million and diluted loss per share of $8.62. Its debt levels over the past five years follow a similar trajectory to those of Suntech Power:

Source: LDK Solar 2012 Annual Report

This year's results show a narrowing of revenue losses over prior periods. Operating margin improved in the second quarter of fiscal 2013 to (82.9%) compared to (89.4%) in the first quarter of 2013 but was worse than last year's second quarter margin of (73.4%). CEO Sam Tong stated that revenue for the quarter was in line with expectations, as net losses have been reduced. The company continues to improve its cost structure and sees signs of improvement in the PV market.

Yingli
Yingli Green Energy (NYSE: YGE) is the world's largest vertically integrated PV manufacturer covering the entire PV value chain. Yingli was negatively affected by decreasing demand for its PV modules and reductions in government subsidies, which in some markets make the switch to solar power viable. There have also been problems in its supply chain with late or failed deliveries of the raw material polysilicon used in production.

Yingli's short-term borrowings declined in 2012 by 8.5% from 2011's borrowings, after rising about 40% from 2010 to 2011. The company's accounts payable balance decreased and stands at $767.1 million, as of June 30. The quarter also had an improvement in the timely payment of short-term debt -- days payable outstanding was 142 days, compared to 161 days in the first quarter. The company, which began operating in 2003, believes that sales will increase from expansion into Europe and the U.S. Yingli also states it has sufficient working capital for its present requirements.

While revenues grew by 8.9% year over year, the second quarter of 2013 had a net loss of $52.3 million and loss per share was $0.33. The company reported a gross margin of 11.8% compared to 4.1% in the first quarter of 2013. Demand from the U.S., China, Japan, and other emerging markets is expected to increase by over 60% in the second half.

My foolish conclusion
The solar energy sector in China is navigating considerable market challenges, which include western tariffs and diminishing government incentives to switch to solar energy. The industry can benefit from rising prices in PV components if it maintains its costs under control. A recent New York Times article explained how the cost involved in building a solar panel manufacturing facility makes up a big chunk of the cost of manufacturing each panel. The current overcapacity faced by the industry forces companies to continue to operate to cover just part of the hefty interest on loans taken out to finance these factories and their equipment. This creates a money-losing situation that's difficult to turn around when demand is low.