In my previous article on the solar industry, I looked at several solar companies from the perspective of institutional investors. The premise of doing so was that the comparative metrics used by the big players could be worthy of attention to the masses. While a reader feedback that the angle approached was refreshing, it would be good if I could elaborate on the company developments with metrics and observations that are generally relevant for retail investors. After running through several financial metrics and ratios, I found that the inventory trend and receivables growth comparison warrant further attention for investors of the solar companies. It is also important to determine the sustainability of demand drivers to avoid investing in ephemeral developments.
Company-specific Developments Key to Valuation Shifts
Casual watchers into the solar names are forgiven for thinking that the fortunes of various players are closely tied together given the way the media has been portraying the industry. Several solar firms could rise or fall in tandem depending on the headlines of the day. For instance, just last week, First Solar (FSLR), Canadian Solar (CSIQ), and Sunrun (RUN) were among the plethora of solar companies that saw their share prices decline following a weakened guidance by SunPower (SPWR). The collective share price correction came despite company specific issues affecting SunPower where the guidance cut was attributed to the adjustment in the time frame on certain projects in Mexico. In June, when U.S. President Donald Trump raised the possibility that the proposed border wall with Mexico could be self-funded in part by using solar panels, solar names generally rose.
Looking at the high correlation between the share price movement of First Solar and JinkoSolar Holding Co (JKS) apart from a short aberration around May 2017, the collective movement appears to ring some truth. Nevertheless, when compared using Enterprise Value which is a comprehensive measure of a company’s total value, the correlations showed clear variations through the past one year. Hence, this demonstrates the value of investigating company-specific issues in understanding the valuation changes of each company.
Besides having the Enterprise Value comparison telling us the individual stocks in the industry have differences, I realized it could reveal which stock could be temporarily undervalued. For instance, for much of the past ten years, First Solar had an Enterprise Value that was the highest among the four common solar names listed in the chart below. In the early part of 2016, it still retained a clear lead over the rest before languishing subsequently and even became the lowest around May of this year. Perhaps if one has a system that sends alerts when such occurrence happens, he/she might be able to take a bet on a rebound which eventually materialized. Just to be clear, the occurrence referred to is when an industry giant suffers a momentary setback, and indicators like its Enterprise Value falls behind its peers when it rarely happens.
Gauging Business Health through Inventory Trend
In general, a rising inventory profile is to be expected in line with rising revenues. It would be ideal if the inventory level can be held steady even as revenue increases. This could happen when sales of products are accelerated, resulting in a higher inventory turnover ratio. What’s most undesirable is, of course, rising inventory amid stagnating or worse, falling revenue. Toy companies Mattel (MAT) and Jakks Pacific (JAKK) are suffering from the latter scenario. I have written an article describing how that portends weaker results. The same appears to be happening for JinkoSolar where inventories have climbed more than 200% over a three-year period. In fact, the rise in inventories accelerated in the recent quarters despite declining quarterly revenue. In the second-quarter of 2016, JinkoSolar achieved sales of $906.38 million. Subsequent quarterly revenues were lower, ranging from $745.69 million to $855.42 million. On the other hand, First Solar and Canadian Solar were able to keep their inventories lean. SunPower has a rising inventory profile in the three-year period but it has at least kept its inventory stable in the past one year.
Another red flag spotted was the rising provisions at JinkoSolar. In the first-quarter of 2016, provisions were $53.91 million. The amount rose steadily to hit $77.12 million by the first-quarter of 2017. While that seems to be a drop in the bucket when compared with the annual revenue at $3.21 billion, investors would do well to consider if the provisions made are adequate. Total receivables have almost doubled from $627.15 million in the first-quarter of 2016 to $1.15 billion a year later. During the period, revenue was averagely at similar levels. When you have sold around the same value year-on-year but face much higher pending receipts, then naturally you become more concerned how much of the sales proceeds you would eventually collect back. Some indication of trouble came in the form of a report by The Wall Street Journal which revealed that Renovate America, which finances purchases of solar panels and energy-efficient appliances, helped its customers with debt repayments if they had problems doing so on their own. Was this an isolated case or just the tip of an iceberg? For First Solar, total receivables were stable in the three-year period and even shows a declining trend in the past quarters. At Canadian Solar, total receivables even fell 24% in the last one-year period while it was relatively stable at SunPower for the past two years.
To fund the additional inventories and products sold before the collection of cash, unless the company is cash-rich, inevitably, liabilities would go up. That rang true for JinkoSolar but with cash from the spin-off of its downstream projects business, it managed to pay down more than half of its debt in late 2016.
Sustainability of Tailwinds
JinkoSolar said that it received “rush orders” from Chinese developers towards the end of 2016. The good demand was expected to continue in the first six months of 2017 due to the impending reduction in China feed-in tariff that was scheduled to occur in June 2017. The management, however, believed that its pioneer qualification into the China Quality Certification Center’s (CQC) Top Runner Program would support demand for its solar cells somewhat. In China, after the rollback in tax incentives for automotive purchases this year, vehicle sales softened and the industry had to rely on offering steep discounts to spur purchases. The doldrum in the auto sector might offer clues to what might happen to the solar orders after the feed-in tariff reduction kicks in.
As for the firming prices in the U.S. for solar panel modules, First Solar CEO Mark Widmar believed that would result in a better gross profit margin outlook in 2017 for the company even after factoring the expected price declines in its “older product” a.k.a Series 4. With the majority of First Solar’s revenue earned in North America, the company would stand to benefit more from the improvement in pricing in the region as compared to JinkoSolar which predominantly sells in Asia Pacific and particularly China. While the share price hikes following speculations such as the one on the installation of solar panels on the border wall proposed by U.S. President Donald Trump are ephemeral, the positive boost from stronger U.S. demand appears to be longer lasting gauging from the all-rounded (shipments, EPS, and revenue) raising of its full year outlook by First Solar.
First Solar Q2 2017 Results Presentation
JinkoSolar Q4 2016 Results Presentation
It seems to be a worthwhile exercise in exploring the various indicators and metrics to compare the investment merits of the various solar names. There are differences in what institutional investors would be concerned about versus what retail investors should be aware of. In my previous article on the industry, I mentioned the need to follow-up on the developments of the company one is keen on as it is not sufficient to simply be aware of the industry changes. In this article, I first demonstrated the variation in how the market values each solar company despite seemingly collective movements in reaction to headline news. Next, I cautioned on the need to monitor the inventory trend and the rise in Total Receivables. Finally, I explored the certain positive drivers and suggested that the tailwinds for First Solar could be more sustainable than those for JinkoSolar.
Note from author: Thank you for reading. My articles revolve around a subject or angle that I feel might have been overlooked. If you would like more of such articles and wish to be informed as soon as they are published, please click on the “Follow” button below the title near the top of this page and check the “Get email alerts.” If you have additional insights on the topic or contrasting views, please kindly share them in the comments section.
Disclosure: I am/we are long FSLR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
8 August 2017 11:26 am
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