There are other red-flags too. The company used to use Crocker Coulson as an IR officer. That is a light-red flag. Crocker you see is not my favorite person as he threatened to sue me over this post on Universal Travel Group. Universal Travel is now suspended from the NYSE.
Crocker Coulson, like Peter Mak, is no longer associated with Trina Solar.
Project” refers to Changzhou Trina Solar Energy Co., Ltd.’s Solar PV Industry Vertical Integration Product Project with an Annual Capacity of 500MV. The Project is located in Changzhou City of Jiangsu Province, to the south of Xinghan Electronic, the north of Nenjiang Road, the east of Chuangxin Road and the west of Keji Road, and to the north and west of Xinxi Road, the south of Nenjiang Road and the east of Keji Road. The content of the Project construction is to build a production base of solar PV industry vertical integration products with an annual capacity of 500MW and reach a production capacity of 250MW for each of mono-silicon rod and multicrystalline ingot, and 500MW for each of wafers, solar cells and PV modules. A “PV Integration Engineering Technology Research Center of Jiangsu Province” backed up by Changzhou Trina Solar Energy Co., Ltd. is to be established. The project has planned to use land in about 596 mus for construction, build an area of 329,983 square meters of new buildings and purchase production equipment (1,064 items per set). The total investment of the Project is USD597,900,000, of which the fixed assets investment is USD392,940,000, and the working capital is USD204,960,000. The sources of the Project funds are as follows: USD200,000,000 as capital funds of the Project; USD93,690,000 raised by the enterprise; USD304,210,000 coming from the syndicated loan.
|Year||Ingots (MW capacity)||Modules (MW capacity)|
The Company's short-term bank borrowings consisted of the following
|Simplified table – 2010 only||$million|
|Short-term borrowings guaranteed by Trina||15|
|Short term borrowings secured by machinery of Changzhou Energy Trina Solar Energy Corp||77|
|Unsecured short-term borrowings||24|
The average interest rate on short term borrowings was 7.11%, 5.14% and 4.04% per annum for the years ended December 31, 2008, 2009 and 2010, respectively. The funds borrowed under the above short-term arrangements have no covenants or restrictions, and are repayable within one year.
These numbers do not quite match the balance sheet as there is another $42 million of "current portion of long-term bank borrowings". So short term borrowings in the balance sheet total $159 million.
Then here is the disclosure that makes it all make sense. It is a doozy - but after I read it much of my original thesis about Trina just evaporated - and was replaced with another thesis. The new thesis is the main content of this blog post. So please double-read this disclosure:
The Company has short-term bank facilities of $483,851,907, $590,622,009 and $1,741,578,929 with various banks, of which $282,496,077, $327,899,446 and $650,880,259 had been drawn down and $201,355,830, $262,722,563 and $1,090,698,670 were available as of December 31, 2008, 2009 and 2010, respectively. Those short-term bank facilities are renewable annually by mutual agreement between the parties.
That $651 million in debt does not appear anywhere on the balance sheet. But it is there and it is due-and -payable at some date in the next twelve months.
And now we have a perfectly reasonable explanation of why there is more than three quarters of a billion dollars in cash on the balance sheet and the company is repeatedly selling equity to raise cash and rolling over lots of short term debt.
They have a really big obligation which is "short-term" and relies on the banks to renew their facility. And the obligation is not on the balance sheet.
So I went looking for it. After all this obligation is sufficient to get Trina to willingly undertake contorted capital management. So I tried to find everything the company has said about "off-balance-sheet arrangements". Fortunately (and a little unusually for this company) there is a remarkably simple disclosure as to the entirety of their off-balance sheet arrangements:
Other than our purchase obligations for raw materials and equipment, we have not entered into any financial guarantees or other commitments to guarantee the payment obligations of third parties. We have not entered into any derivative contracts that are indexed to our shares and classified as shareholders’ equity, or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or that engages in leasing, hedging or research and development services with us.
So it is purchase arrangements. There are no other off-balance sheet obligations.
They even spell out what those forward purchase contracts are. Here is the key paragraph:
As of December 31, 2010, the Company had entered into certain long-term silicon procurement contracts, under which the Company agreed to purchase silicon materials in an aggregate amount of approximately $14.6 billion over the next four to seven years.Like wow. Like hooley-dooley. This is the disclosure which makes Trina make sense.
You see in the last quarter revenue was only $550 million. That is just over $2 billion a year. It is roughly $14 billion over seven years. The entire revenue line is committed to buying polysilicon.
This only makes sense if the company grows and grows and grows. Without massive growth this company can't meet its purchase obligations.
And we know what is backing the purchase obligations - lines of credit secured by bank loans and not appearing on balance sheet.
If this company stops producing lots and lots of panels (and buying lots of silicon) it goes bust because it is committed to buying the silicon.
People ask why the Chinese solar panel makers are massively expanding production even though there is a glut: well there is your answer.
Italy was a huge market for utility-scale solar plants. These require viable financial markets because a solar-farm is like a power station where you purchase all your fuel up front. They are capital intensive beasts. And if you haven't noticed the Italian financial markets are not working as well as say eight months ago.
And the subsidies are being reduced in markets like Australia and Germany.
But - driven by their humungous polysilicon purchase agreements the companies are driven to expand production. If they do not their polysilicon purchase agreements make them go bust.
If they can sell the panels at good margins they are going to make a fortune. The companies are growing very rapidly - and are compelled to do so by their polysilicon purchase contracts.
If they can't sell the panels then the companies will burn and the 750 million in cash sitting on the balance sheet will evaporate. It will be transferred to the polysilicon makers. The $650 million drawn bank loan - the one not on balance sheet - will suck them into financial oblivion.
And this contract is not easy to renegotiate because the polysilicon makers hold the bank lines which is the equivalent of holding the cash. If Trina tries to get out of the contract then the polysilicon maker just draws the bank line and gets paid anyway. And Trina will wind up owing the money to the bank...
Success or failure for Trina all depends on whether they can profitably sell the panels.
Massive and compelled growth at high margins will send this stock to $50 or more. Massive and compelled growth when you can't sell the panels at good margins will send the stock to zero. There is not much in-between - this company is attached to the rocket-ship and and will either explode or go into orbit. It has to double in size and double in size again. It may even have to double again after that. By the end of this year it will be over ten times as large as at the end of 2007 - and it is compelled to grow beyond that too.
This is (with apologies to the Clash) death or glory Chinese stock market style.
Now you can see why we at Bronte have rejigged our position so we make money at the tails of the distribution and lose money with a sideways stock. Both $50 and $0 are hugely profitable to us. $15 in a year is ugly but given the power of this rocket-ship we don't think that is going to happen. Strapped onto a rocket-ship you are going to have a wild time.
So is it death or is it glory for Trina Solar?
Lets be blunt. At the moment it is looking like death. If nothing changes death comes within nine months, and probably far faster than that.
Production is going up, sales are going down and the difference is sitting in inventory. The company is selling some product but is also collecting its receivables much slower. The changes in the last balance sheet are a just startling - this is from the end of the first quarter.
Unaudited Consolidated Balance Sheet
(US dollars in thousands, except share and per share data)
The things to notice in this balance sheet is that inventory went from $79 million to $180 million in a single quarter. Accounts receivable went from $377 to $543 million.
They finally spent a lot on property, plant and equipment - probably over $100 million - as PP&E went from $571 to $664 million.
All of this is cash consumptive - and the cash balance went from $753 to $490 million. That cash fall happened whilst liabilities went up. They did not repay any debt. Cash burn was $263 million. At that rate of burn they die in less than seven months from the end of the March quarter - that is sometime about October. They might delay death by collecting the above-mentioned receivables - but that is only a short-stay of execution.
Revenue went down even though production went up (pricing was terrible). If they actually tried to sell the product to people who paid them (rather than sit in warehouses as inventory or sell it to people and count it as "receiveables") then you could just imagine how ugly the pricing would have got.
The company does not publish a quarterly cash flow statement but there was this amazing exchange in the last conference call...
Gordon Johnson - Axiom Capital Management: Just a couple of housekeeping questions, what was the operating cash flow in the quarter?
Terry Wang - CFO: It's negative for more than $100 million.
Gordon Johnson - Axiom Capital Management: Negative $100 million?
Terry Wang - CFO: It's more than $100 million, $120 million around roughly.
I figure $120 million negative is an underestimate - but without a cash flow statement that is a guess.
Bluntly though it looks like death because you can't run a business with that much negative cash flow.
This company has "profits" but negative cash flow because (in accordance with accounting standards) it counts increased receivables and increased inventory as part of its profits.
And the negative cash flow looks like it going to get worse. Much worse. You see the company pre-announced the second quarter earnings. The critical phrase is this.
While shipment volumes in the second quarter were our highest ever, sales were adversely impacted by extended slower demand and high industry inventory due in part to recently issued regulatory revisions and reduction in solar subsidies in Italy,” said Mr. Jifan Gao, Chairman and CEO of Trina Solar. “We expect a significant improvement in production costs and an increase in shipment volumes in the third quarter."
Shipments are up (320MW to 395MW in consecutive quarters) but sales are down. Guess where inventory is going? Presumably some warehouse somewhere.
Pricing has deteriorated further too - so to be blunt, cash flow has got to be getting worse. There is a possible offset if they collect the increased receivable balance described above.
Moreover they expect a significant increase in shipment volumes in the third quarter. Of course shipment volumes are going up - they have to driven by the massive polysilicon purchase obligations.
But they better hope they can sell those shipments or they are dead very rapidly. You can't bleed a couple of hundred million a quarter for very long. Not when you have to roll all that bank debt and you are obligated to issue bank guarantees over all those purchases.
And given the big markets for this are in Southern Europe (where solar-farms are suddenly hard to finance) the chance of selling all that product is reduced.
So I think the outcome is death and our position in the stock is sharply weighted towards death.
The glory-case for Trina solar
Fast growth into declining sales does not necessarily mean death if sales miraculously turn around. A large Chinese solar subsidy might do that but the recently announced solar subsidy is set at a low level (feed in tariffs are under a third of the European equivalents). The really rich markets (Southern Europe) don't look like they are coming back soon.
The second - and more important way that they can sell the massively increased production is if they cut prices far enough that the relatively expensive capital markets of Europe can finance the projects. They will do that if they get (even-more) super-efficient and if the polysilicon costs drop far enough.
They have been very efficient in the past - processing costs have dropped but nothing like as fast prices for panels.
But the real cost drops have been driven by polysilicon which peaked at over $400 per kilogram and is down by at least 80 percent.
The main polysilicon contract is attached to the 2009 annual report. This contract specifies the way in which polysilicon prices in the contract are to drop if the spot price for polysilicon drops.
In other words they are obligated to buy lots and lots of polysilicon - they are just not obligated to buy it at the current price.
The contractual terms of their lending agreements require that they do actually process the polysilicon.
In other words if they can get their processing costs low enough and they can grow the market enough, they might be able to sell all of their obligated polysilicon by growing the market.
If this happens the company - now on a PE of 3 - will (at least) quadruple in size and get repriced as a growth stock. $50 in that case is conservative. Glory for this company is a long way up from here. A very long way up from here.
But they better start getting the costs down and selling the product really rapidly (like right now) because the current large and increasing negative cash flow will leave this company as just more road kill in the US listed Chinese space.
For thought and conversation.