It's been an up and down few years for solar giant Canadian Solar (NASDAQ:CSIQ). The company went from profitable to losing hundreds of millions of dollars along with most of its competitors a few years ago only to make a comeback and return to profitability over the last year.
But profits are down in 2015 and will likely fall again next year as the windfall from Canadian projects moves into the rearview mirror. As results get worse, Canadian Solar continues to have its foot on the growth gas pedal, looking to expand production by almost double between 2014 and 2016. Is that a recipe for disaster or global domination in solar?
Earnings are down big
Canadian Solar's recently released third quarter revenue was down 7.1% from a year ago to $849.8 million and net income dropped 70.9% to $30.4 million, or $0.53 per share. The decline is primarily due to fewer high margin projects in Canada being sold, but it also revealed the razor's edge the company is walking on.
Gross margin of 14.9% was above the company's guidance of 12% to 14%, but it's well below industry leaders that are reporting gross margins of over 20%. The only way to offset that low margin and remain profitable is to spend less on operating expenses, particularly research and development, where the company spent just $4.1 million last quarter.
The problem with that is this is a time when improving efficiency and technical capabilities offered to customers is more important than ever. The companies that are improving profitability are moving up the value chain, not leveraging commodity products in solar.
Expansion plans are under way
As margins fall, Canadian Solar is executing on an ambitious expansion plan. By the end of 2016, the company expects to have 3.4 gigawatts of cell capacity and 5.6 gigawatts of module capacity, up from 1.5 gigawatts and two gigawatts respectively at the end of 2014.
The theory is that solar demand should be extremely high for the rest of 2015 and through 2016 as the U.S. soaks up as much demand as it can handle before the ITC falls from 30% to 10% in 2017. But what happens then?
What happens in 2017?
The biggest risk solar investors face is companies expanding too fast, seeing technology pass them by resulting in low margins, and then having too much debt to be able to pay off while investing in the future. This is what happened to Suntech Power, Yingli Green Energy, Q-Cells, and countless other solar companies that were once dominant in the solar industry.
So far, Canadian Solar has managed to keep its debt at a relatively small $1.7 billion, offset by $932 million in total cash and about $500 million in project assets. So, the balance sheet isn't as big a concern as it has been for other manufacturers.
Margins, however, are lower than many competitors and show no signs of increasing significantly. One reason for that is the company's commodity solar panels, which aren't differentiated from most competitors and force Canadian solar to compete on price in the marketplace.
Competing on price alone may be fine for the next year or so, but if the U.S. solar market collapses in 2017 and there's a continued push to more and more efficient solar panels we could see a plunge in profitability. That's what's concerning about the low margins and low R&D spending today.
What is Canadian Solar's future?
The problem Canadian Solar has is that it's stuck in no man's land in the solar industry. It's a module supplier and is building a systems business, but it doesn't have a technology advantage over competitors and doesn't have access to low cost financing.
Without some way to differentiate itself the company is stuck fighting in a commodity market that's becoming more of a technology market by the day. That may be a way to survive, but it's not a high probability of success for investors. Without improved products that will push margins higher I don't see this Chinese solar panel maker as a good bet in today's solar market.