Trina Solar (NYSE:TSL) released its second quarter earnings on August 20, displaying a good set of numbers that were aided by higher shipments, stabilizing prices and some cost improvements. (See Our Earnings Preview: Trina Solar Preview: Gross Margins And Shipments Are Expected To Improve) The company reported quarterly revenues of around $441 million, up by around 27% since the same quarter last year while the net loss narrowed to around $33 million from around $92 million last year.  Following the earnings, we have revised our price estimate for Trina Solar significantly from around $5 to about $8, taking into account the company’s improving outlook.
Here is brief a look some of the trends underlying the company’s quarterly earnings and the rationale behind the increase in our price estimate.
Higher Panel Shipments Expected, Driven By Markets Like China And Japan
We have increased our forecast for Trina Solar’s panel shipments for its “Rest of the world” segment of our model (which includes markets like Japan, China, India and Australia) from our previous estimate of around 1.7 GW to about 2.8 GW by the year 2020 (the terminal year of the Trefis forecast period) as we expect demand to grow faster than we had previously anticipated.
During the second quarter, Trina Solar’s quarterly panel shipments grew by around 54% since the same quarter last year to around 647 megawatts (MW), aided by strong sales in growth markets such as China, Japan and the U.S. Sales to China were particularly strong and accounted for about 26% of quarterly revenues. The firm expects Chinese shipments to touch 650 MW (27% of shipments) this year, up from around 200 MW last year, and we believe that there is still more room to grow.
China is expected to become the world’s largest market (by volumes) for solar power equipment this year, and the country’s State Council has plans to quadruple solar power capacity to around 35 gigawatts (GW) by 2015. This translates to an addition of nearly 10 GW of capacity each year over the next two years alone. Trina Solar currently has close to 10% market share in China, and we believe that this could increase going forward given the recent bankruptcies and talks of consolidation within the Chinese solar space. ((Seeking Alpha)) Assuming that new installations in the country increase to close to 13 GW by 2020 and Trina Solar is able to garner around 12% market share, this would amount to around 1.5 GW in annual shipments to China alone by 2020.
The Japanese market also looks promising for Trina Solar. For this year, the company expects Japan to account for nearly 11% of overall shipments (around 240 MW), up from just about 3% last year. Japan is a lucrative market for solar products since average selling prices in the country are among the highest in the world. While Japan was largely viewed as a market for residential solar products until recently, the country has seen non-residential and utility scale solar installations surge of late as it continues to diversify its electricity generation mix following the accident at the Fukushima nuclear reactor.
We believe that the increasing shift to non-residential installations could be a positive for Chinese polycrystalline based panel manufacturers including Trina Solar. While the Japanese market overall (both residential and non-residential) is generally skewed towards more compact and efficient panels (such as monocrystalline panels), utility-solar installations are relatively less demanding from an panel size and efficiency standpoint making polycrystalline panels quite well suited for these applications. (Related Read: A Comparison Of Solar Technologies And What They Mean For Companies)
New installations in Japan for this year are expected to cross 5 GW, and we believe that growth could remain relatively strong in the near term.  Trina Solar expanded its manufacturing capacity for its high-end polycrystalline solar panels last year and these panels could be a good fit for the Japanese market. We believe that the company should be able to double its Japanese shipments to around 500 MW by 2020 as the market expands. Other markets such as Australia and India which together currently account for about 13% of the company’s shipments are also poised to grow and we believe that they could help to bring the company’s “rest of the world” module shipments to around 2.7 GW by the end of our forecast period.
Panel Prices Are Stabilizing
Solar panel prices have seen a precipitous decline over the last few years due to an aggressive capacity expansion drive by Chinese companies. Over 2012, we estimate that Trina Solar’s panel prices declined by around 40% to about $0.80 per watt. However, things began to look better in Q1 with prices declining at a slower pace (around 6%) and prices actually stabilized in Q2 as demand from emerging solar markets grew. While there have been indications from some Chinese manufacturers such as LDK Solar (NYSE:LDK) that prices could even increase during the second half of this year citing rising demand, we currently remain cautious in our outlook and expect panel prices to remain relatively flat at around $0.68 per watt through 2020, reflecting the fact that there is still excess capacity in the Chinese solar industry. China’s total solar panel manufacturing capacity alone exceeds the estimated worldwide demand (around 31 GW) for photovoltaic solar products for 2013.
Gross Margins Will Improve On Better Non-Silicon Costs
Gross margins rose to around 11.6% this quarter up from around 1.7% in Q1 2013 thanks to stabilizing prices and some cost improvements. The company is targeting a return to profitability (in terms of net profits) by the fourth quarter of this year and indicated that it could post positive operating margins in the third quarter itself.  We have increased our forecast for Trina Solar’s gross margins, expecting them to touch around 19% by the end of the Trefis forecast period as we expect the company to continue with its cost reductions while the average selling prices for panels stabilize.
Manufacturing costs for solar panels can be broadly classified as silicon costs and non-silicon costs. We estimate that silicon costs, which include the price of the polysilicon used in manufacturing wafers, account for about 25% of the company’s direct manufacturing costs while non-silicon costs, which include other direct production costs such as other raw materials, production overheads and manpower account for the remaining 75%. While there remains a possibility that silicon based costs could increase going forward given that polysilcion prices are hovering just above all time lows, we believe that there is scope for the company to improve non-silicon costs on a per-watt basis given the better utilization rates and economies of scale that come with higher volumes. We believe that this should have a positive impact on overall production costs, helping the company’s gross margins.
Capex And Other Model Changes
In line with the higher shipments forecasts, we have raised our estimates for the company’s capital expenditures. Trina Solar currently has an annual manufacturing capacity of around 2.4 GW for its panels and there is a chance that the company could reach 100% capacity utilization towards the end of this year with a possibility that it may have to expand its manufacturing capacity over the next few years. We forecast that Trina Solar’s capex as a percentage of gross margins will increase to above 40% by 2020, up from our previous estimate of around 33%. We have also raised our forecasts for the company’s change in net working capital and other net operating assets mirroring our rising shipment estimates.
Our revised price estimate for Trina Solar stands at around $8, up from around $5 previously. Breaking up the price impacts of our driver changes, the revised gross margins forecasts increased our price estimate by roughly $3 per share while the higher shipment forecasts raised the price estimate by around $4 per share. The higher projected cash outflows from higher capex, net working capital and other net operating assets investments as well as the change in the company’s net debt position impacted the price negatively by roughly $4 per share, resulting in a $3 net increase to our price estimate.Notes: