A Look At Trina Solar’s Key Risks

Trina Solar (NYSE:TSL) has had a good year so far. The company’s stock price has more than doubled since January thanks to a surge in demand for solar panels from markets such as China as well as higher utilization rates and operational improvements that have positively impacted margins. The company also remains one of the most stable Chinese solar companies from a balance sheet perspective given its relatively manageable debt load. While we believe that the recent rally is largely justified, we see a couple of key risks that the company faces including potential cost pressures, continuing overcapacity in the Chinese solar industry and the company’s relatively small exposure to the lucrative downstream solar space.

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Overcapacity Persists In Chinese Market

Trina’s outlook for panel shipments this year is very positive at between 2.3 gigawatts (GW) and 2.4 GW, meaning that the company could be approaching 100% capacity utilization for this year. Trina has also mentioned that it is seeing some stabilization in average selling prices. While this bodes well from a margin and revenue standpoint, we believe that there could be a risk in the medium term as there is still significant overcapacity within the Chinese solar industry. Total solar manufacturing capacity in China alone stands at around 45 GW per year while the projected global demand for solar panels in 2013 is substantially lower at around 35 GW. ^[1] Even some first-tier manufacturers such as LDK Solar have been struggling with massive under utilization in recent times. While Trina does have a slight edge over other Chinese solar companies given that its products are reasonably differentiated from other Chinese manufacturers and also due to its relationships with large developers, competition from other Chinese vendors could remain fierce in the near term, posing a threat to the overall pricing environment.

Labor And Polysilicon Costs Could Rise

Over the past two years, panel manufacturing costs across the industry have fallen from above $1 per watt to around $0.50 per watt largely due to the decline in prices of polysilicon and consumable materials. However, we believe there is a possibility that polysilicon prices, which are currently just off their all time lows, could increase given that the Chinese government has been looking to bring about consolidation within the domestic polysilicon industry. Although  polysilicon costs now account for just about 20% to 25% of panels manufacturing costs, an higher commodity prices will nevertheless have an impact on the company’s overall manufacturing cost base. Labor costs in China have also been rising sharply (by as much as 20% per year over the last decade). ^[2] While the manufacturing process for solar cells is largely automated, the traditionally lower labor costs in China have given Chinese companies a slight edge over their European and American rivals. If labor costs continue to escalate at this pace, it could hinder Trina Solar’s cost competitiveness compared to its international rivals.

Small Presence In The Downstream Solar Space

The solar panel business has become largely commoditized over the last few years as Chinese manufacturers ramped up their production capacity leading to a glut of panels that has impacted selling prices and profitability industry-wide. The solar project development (also known as downstream) business on the other hand has been thriving thanks to lower equipment cost which is making solar power an increasingly viable alternative to conventional sources of energy. The downstream business has relatively healthy margins since it involves providing value added services such as design and construction in addition to procuring equipment. For example, First Solar (NASDAQ:FSLR), one of the world’s largest solar companies, had gross margins of around 10% for its panel business last year while the margins for its projects business stood at over 35%.

Trina Solar’s business has largely been geared towards manufacturing panels rather than building projects. The company’s progress in the downstream space has been relatively slow even when compared to other Chinese firms such as Yingli Green Energy (NYSE:YGE) and LDK Solar (NYSE:LDK). We believe that the company’s relatively short track record in building large scale projects could prove to be a disadvantage in the near term.

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1. Reuters [↩]
2. WSJ [↩]