Two of China’s biggest solar companies Suntech Power (NYSE:STP) and Yingli Green Energy (NYSE:YGE) are continuing to battle a turbulent solar market. Both the stocks have performed dismally this year, shedding more than half of their market value. Both companies posted sequential quarterly losses and suffer from heavily debt-laden balance sheets. Although both companies have managed to clock respectable modules shipments, they continue to suffer due to the plummeting prices of photovoltaic modules.
Even though Yingli and Suntech are quite distinct in terms of their operations and product mix, we believe that many of the factors that are driving the value of these firms are quite similar.
Weak Margins Despite Reasonable Module Sales and Capacity Utilization
Yingi and Suntech, like most other Chinese solar firms, have invested substantially in beefing up their manufacturing capacity over the last few years. However their approach has been relatively more rational compared to their peers such as LDK Solar (NYSE:LDK) that expanded too rapidly.
Yingli’s production capacity stood at 2.45 GW in Q2. The company’s guidance for PV module shipments for this year falls between 2.1 and 2.2 GW, which represents a growth of about 30% over last year. Considering these figures, capacity utilization would be around 90% for the year.  For its part, Suntech Power is planning to maintain its cell manufacturing capacity at 2.4GW this year, choosing to invest on efficiency improvements rather than capacity expansion. The company has provided sales guidance of between 1.8 and 2 GW of modules, which is marginally below last year’s sales. 
Despite their relative prudence in capacity optimization, both companies continue to post significant losses due to the steep fall in module prices. Yingli reported gross margins of about 4.6% in Q2, while the situation was a lot worse at Suntech, which reported gross margins of -10%. We expect the gross margins to improve over the next few years, as supply-demand rationalization occurs in the solar panel market. Furthermore, we believe that the Chinese solar industry is ripe for consolidation, with a potential for larger firms like Suntech and Yingli to acquire smaller players. This will also help to enhance profitability.
We have a price estimate of $1.17 for Suntech power, about 31% ahead of its current market price.
Somber Outlook for Europe
As of last year, European sales contributed to about 61% and 45% of Yingli and Suntech’s total revenues respectively. Although we expect the European business to continue to contribute significantly to the revenues of both companies, we believe that their products could face strong price competition in the near future. The effect of recent subsidy cutbacks in key markets like Germany and Spain and the weak European economy may further hamper their already low pricing power. A lot of their future prospects in Europe also hinge on the outcome of the recently initiated anti dumping investigations – an imposition of punitive tariffs could give both firms a severe price disadvantage compared to European manufacturers.
Utility Scale Projects In North America
In North America, demand for PV products has been strong for much of the year thanks to the growth of utility scale projects. However, Yingli and Suntech face strong competition from US manufacturers like First Solar and SunPower that have made significant headway into the segment.
To firm up their presence in this market, Yingli and Suntech have been releasing products that cater specifically to utility-scale projects. For example, Yingli recently announced new 72 Cell PV modules with a 1000V rating, which allows a larger number of panels to be wired together, bringing down the balance of system costs. 
Suntech also made a similar move by introducing its Utility-scale 1000V Ve-Series panels . Suntech is also introducing products that are manufactured within in its US factories that comply with the Buy American act. The Buy American Act gives a preference to American made goods for government purchases and contracts. 
We have a price estimate of $2.16 for Yingli Green Energy, which is about 30% ahead of its current market price.
Opportunities in China and Other Emerging Markets
China will play an increasingly important role in the growth strategy of both companies. The Chinese market accounted for 22% of Yingli’s total revenues in 2011, up from a mere 4% in 2010. The growth in Chinese revenues over the last two years has been similarly large for Suntech. We expect this trend to continue, thanks to proactive measures by the Chinese government to boost domestic solar installations. The National Energy Administration (NEA) of China seeks to achieve a cumulative installed capacity of 50 GW by 2020, up from the current 3.6 GW. To accomplish this, the government is providing incentives for solar panel installations under its Golden Sun scheme and has also initiated feed-in-tariffs of up to RMB 1/kWh for solar generated electricity. Growing Chinese demand will allow these firms to mitigate their dependence on the export markets.
These firms are also counting on other emerging markets like India, South Africa, Brazil and Thailand to provide new avenues for growth. These countries boast of abundant solar resources and an almost insatiable need for energy to power their rapidly expanding economies. As solar power approaches grid parity, it will become an even more attractive proposition in these price sensitive markets.
Chinese Government Support To Alleviate Weak Financials
The substantial capital spending funded by debt and negative margins have taken a toll on the balance sheets of both the companies. Suntech’s net borrowing at the end of the first quarter was about $1.6 billion while its market cap is around $530 million. The situation is no different for Yingli, which had a net debt load of about $1.8 billion at the end of Q2, with a market cap of just $255 million. 
With such a precarious financial situation, both firms have been counting on support from the Chinese government for their survival, and thus far, they seem to be having their way. Last month the China Securities Journal reported that the China Development Bank would prioritize loans for 12 of the largest solar firms, including Yingli and Suntech Power. Apart from funding provided at the national level, solar firms are also receiving support from their regional governments. Last week, news broke that Suntech was the beneficiary of an emergency loan from the regional government of the City of Wuxi. We believe that the Chinese government will not only continue its support of larger firms like Suntech and Yingli, but also encourage consolidation within the Chinese solar space.Notes: