Wednesday, August 24, 2011

Trina Solar conference call notes

Bronte Capital is both long and short Trina Solar. If Trina Solar shares wind up at $50 we make out like bandits.

If Trina Solar goes rapidly to $2 we also make out like bandits.

We don't like sideways: a share price of $12.50 - $18 is uncomfortable and will cost us a few percentage points of our fund. Outside that range we are comfortable.  Far outside that range and we are very happy indeed.

We are weighted short: we would prefer $2 to $50 and we think $2 is more likely. But $50 would be just fine too.

The Trina results were more or less exactly as I predicted. (The earnings miss was obvious - I predicted a few cents per share worse... but that is not important.)

The balance sheet decay was more or less as I predicted it. The company burnt a lot of cash. I was wrong about one thing: the willingness of the banks to lend lots of money short term to a company where the credit default swaps are priced over 1400bps.

The willingness of banks to extend credit to a company with such weak credit profile weakens my short thesis. It is hard to go bust if you have banks that are that understanding. So I guess all-in-all the result was marginally better for the company than I expected. I expected them to be running low on cash - but they are not - they are just running up short dated debt very rapidly.

After listening to the results I listened to the conference call which I thought was dreadful: I was completely convinced the stock was going to crater and it was indeed weak in the pre-market. The doyens on the Yahoo! chat board (whoever they may be) had the same view. Instead the stock went up fast. Guess that happens with low PE ratio high short interest stocks. Longs are gloating. Shorts are puzzled.

Notes from the Trina Solar conference call

This blog is a fan of Fox News. The slogan is "we report, you decide" and then we will give you our opinion anyway.  In this light I want to extract some highlights from the call.  Some of the executives are non-native English speakers so you will need to forgive the sytnax.

Jifan Gao (CEO): In the second quarter, our sales were to some extent expanded in the market of financing and higher inventory due to the Italian solar subspace changes in earlier May. However, we experienced shipment increase due to our increased sales to Germany and U.S.

That figures. Italy was well known to be a problem. The US is growing fast off a small base. Germany however they did very well in.

Pricing however was an issue:

Terry Wang (CFO): ASP (average selling price per watt) was approximately $1.46 in the quarter versus $1.71 previously.

I guess there is more pain to come. These prices are higher than the retail price (AUD1.35) offered yesterday by a cold caller in Australia.*

Still the CEO laid out the well known bull story:
Terry Wang (CFO): The sequential decline [in margin] was primarily due to the significant decline in module ASPs, which has started in April, we realized client reductions due to renegotiations of a long-term polysilicon feedstock and wafer agreements in early June. This ASP versus cost timing differential to extend have an impact on our gross margin. In recent weeks, we have seen module ASP stabilizing as well as material prices bottoming out bring forth significant manufacturing costs reduction in the current quarter.

In other words selling price fell sharply over the whole quarter (it started in April) but they only renegotiated their supply costs in early June so they had a margin squeeze. As they have now renegotiated their supply costs they should have a margin expansion in the future.

Moreover he says that selling prices are stabilizing which - given falling input prices - strengthens the case for better margins in the third and fourth quarter.

They quantified the costs later in the Q&A. They had 73c per watt of non-poly manufacturing costs and they think that will fall to 70c. They had 43c per watt of poly costs and the "poly costs dropped drastically". I could quantify further: they use roughly 6 grams of silicon per watt. The spot silicon price is about $50 per kilogram so they use roughly 30c of silicon per watt. If the silicon contract has been reduced to that spot price and they achieve their 70c non-poly cost they should have costs of about $1 per watt. They purchase some wafers as well and told us that that raises their average cost by 4-5 cents - so they are expecting costs about $1.04 per watt.

But that was the extent of the good bit of the conference call. From then it was weaker:
Terry Wang: As we look ahead in light of the current global economic and operating environment, our capital expenditure strategy and capital expansion decision will remain closely tied and adapted to market demand conditions.
This doesn't look right. The company has been growing capacity at a massive rate despite demand problems and falling prices and they have announced further capacity expansions.

The CFO further highlighted their ability to deal with the cycle saying:
Terry Wang: We demonstrated our ability to manage and preserve reasonable cash balance for liquidity and working capital purposes so that we can remain nimble in constantly changing market and have a buffer against any downturns or upturns.
Really? So is that why they expanded capacity into a demand downturn and relied heavily on their banks?

By this point I concluded they might be making it up. But it got worse:
Mark Kingsley (COO): as for current outlook in the third quarter, we are benefiting from several positive trends, which includes a growth recovery in Europe, increased order rates from new markets, and improved demand in the U.S. linked to the cash grant subsidy windows.
Now I am sure they are making it up. Does anyone really believe that this current quarter is showing a growth recovery in Europe? Really?

After that the Chief Operating Officer piled it on:
Mark Kingsley: Continuing our drive for geographic expansion, we recently announced our second strategic partnership in Australia with Origin Energy, which we believe can strengthen and sustain our market position as this area’s residential segment continues to expand.
This is at its kindest an exaggeration. Origin Energy recently confirmed to me in writing the nature of this strategic partnership:
Origin has not put out a release as it is simply part of our ongoing supply arrangements and not material in its own right.  Trina is one of a number of suppliers we use.

Angus Guthrie
Group Manager, Investor Relations

But it only got worse from there. The CFO started to contradict himself on selling prices:
Terry Wang (CFO): ... for the ASP (average selling price per watt) side, it’s uncertain and then now the markets are volatile and we have a – this quarter’s ASP target and because last quarter we missed it and because we didn’t realize that in June that the ASP dropped drastically, so I have to – and foresee that the potential of volatility for the ASP side. 
You see earlier the CFO told us that the ASP dropped in March and they renegotiated the Silicon contracts in early June. That was the key for the margin expansion story. Now he is telling us that the ASP "dropped drastically" in June (and if it is mid-June it is after they renegotiated their input prices). This suggests a margin contraction in the coming quarter not a margin expansion: it demolishes the bull case.

The CFO's latest statement is entirely consistent with the cold-call I received yesterday offering me bargain panels to install on my roof.

I was wondering if this call could get any more surreal. I did not need to wait long for the Chief Operating Officer to oblige. He was asked about the situation in Italy in September:

Mark Kingsley (COO): I have been waiting for Italy since I got here. So, we are actually seeing some good activity finally. And we have some pickup in activity. We see it. Obviously, our historic Italian account is at the utilities. We also see Spanish accounts that a lot of them actually served projects there. So, after much waiting and unclarity, we are seeing some pickup in demand. There is – we still have a mix of utility projects in commercial rooftop there. And so what we are seeing moved quicker was the stuff that was utility that was finishing off and now it’s blending into commercial rooftop.
Let me explain something. A solar farm is a power station lasting 25 or more years where you pay for all of your fuel costs up front. They are capital intensive beasts and they absolutely require ready access to finance.

Mark Kingsley is trying to tell us that activity in a capital intensive finance dependent business has picked in Italy right now. He is saying the same thing about Spain.

Of course the Italian (and Spanish) financing system is working just fine right now. Mark Kingsley is seeing it. We should all rejoice in the sudden turn-around.

My view versus the market

Its the job of a hedge fund manager to disagree with the market sometimes. But I have been around long enough to know that often the market spots the improvement or deterioration in a business before I do.

The market thinks the results and the conference call was good enough and they took the price up. I disagree.

The bull story was that selling prices fell in April but stabilized later and the input prices (mostly polysilicon) were renegotiated down in June. Therefore margins reached a cyclic low this quarter and should improve.

That story was contradicted later when the CFO said that selling prices "dropped drastically" in June.

Then the company said that it was "nimble" and that it could manage its growth and capital expenditure to demand but that ability was not reflected in the accounts which show a sudden massive reliance on bank finance.

They say that demand improvement is coming from Europe or so they say. Indeed they say that in the current third quarter they are "benefiting from a growth recovery in Europe".

Then they simply repeated their story about their new "strategic partnership" in Australia as more support for the increased demand. That strategic partnership is just a competitive customer relationship where Trina is one of many suppliers.

And finally they told us that they are seeing more demand right now for capital intensive projects in Italy and Spain. This is not in their view a future hypothetical turnaround. It is that they are "actually seeing some good activity finally".

This was an 8 am conference call. In Alice in Wonderland the Queen says that she "sometimes believed as many as six impossible things before breakfast".

Maybe the Queen was an equity analyst.


*My mistake: someone cold-called me offering to sell me solar panels for my house. I took a serious interest for reasons that should be obvious to all my readers. Now the guy won't leave me alone. John Hempton is now suffering obsequious salesmen for his trade.


Charles Butler said...

Not exactly identical, but Spanish wind generator biggie Gamesa is on track to sell zero percent of its production inside its home country in 2011.

A look at solar panel builder Solaria (SLR.MC at Yahoo) will give you a good idea of what that domestic market looks like.

Recent regulations requiring new residential buildings to incorporate solar panels might have saved them - except 'new building' became an oxymoron.

Anonymous said...

You know, by the remote look of it, their entire fortune relies on the exact terms of their silicon purchase agreement. I don't quite get (their/your - got only one source here) story about contracting astonishing amounts of silicon purchase before any other plans could be laid up, but if that's the story, then their cash burn is fully a function of what exactly and at what price they got to get. Merely an expiring contract could make a perfect bull case.

Tho admittedly I totally fail to get the basic underlying story - how could they have contracted overwhelming amounts of supplies to the point of betting their survival on it. Is polysicilon such a rare commodity you got to gewt out of your way to acquire?


Owen said...

Where did you get Trina's CDS quote? I can't find it on Bloomberg.

Nemo Incognito said...

Owen - run ovcv on the convert. Depending on recovery and vol assumption I csnt get anything tighter than mid teens.

John Hempton said...

Nemo Incognito answered the question for me.


J said...

"If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem." - J. Paul Getty

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