Two Scenarios That Could Lead To Significant Upside For Trina Solar’s Stock

Trina Solar (NYSE:TSL), the largest solar panel manufacturer, has seen its stock price soar by close to 50% this year, driven by strong demand for solar panels, its growing footprint in the downstream solar market and some cost improvements. Additionally, Trina’s relatively stable balance sheet could be making it attractive to investors looking for exposure to China’s large and fast growing solar market, without having to take on high levels of solvency risk.

We currently have a $15 price estimate for the company, which represents a 15% premium to the current market price. In this note, we take a look at two scenarios relating to Trina’s manufacturing costs and its project development business that could result in a significant upside to the stock price.

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Manufacturing And Technology Improvements

Given the uncertain pricing conditions in the solar market, Trina Solar has largely relied on reducing its direct manufacturing costs and improving its manufacturing efficiency to drive margins. Between 2010 and 2014, manufacturing costs fell from over $1.10/watt to about $0.48/watt. However, we estimate that only about 30% of the cost improvements came from manufacturing process optimizations and improvements in operational efficiency. On the other hand, as much as 70% of the cost decline came from lower polysilicon prices and tighter controls on the company’s supply chain. These lower raw material costs were largely attributable to the nearly three-year long oversupply situation in the solar market, and we believe that such improvements may be difficult to replicate over the longer term, as demand improves. For instance, based on data from GCL Poly, the largest polysilicon manufacturer, prices for polysilicon were under $20/kilogram (excluding taxes) during Q1, down from over $100/kg a few years ago. The current market prices for polysilicon are believed to be below the cash costs of some producers and the broader solar supply chain in general isn’t very profitable. There is a possibility that prices could increase or remain stable at current levels, as unprofitable players exit the market and as demand rises.

We think that the next major round of cost reductions will depend on an improvement in manufacturing technology that can boost conversion efficiencies and bring down input costs. However, this will not be easy. Almost all Chinese polycrystalline module manufacturers, including Trina Solar, use similar production technologies and their broad technology roadmaps are likely dependent on solar equipment manufacturers. This makes it difficult for a particular company to maintain meaningful cost leadership over the rest of the industry. In other words, when there are significant improvements in manufacturing technology, it will likely be available to all players.

That said, Trina has been making some progress on the proprietary technology front, setting new efficiency records for multi-crystalline panels, in addition to also setting records for high efficiency p-type and n-type silicon solar cells. If the company is able to innovate to improve panel efficiencies and costs meaningfully, this could have a notable impact on our price estimate. Our $15 price estimate for Trina assumes that gross margins will increase from around 22.5% in 2014 to around 25.5% by 2021, driven primarily by higher value-solar systems sales. However, if the firm is able to make significant improvements to its manufacturing technology, bringing down direct costs so as to improve margins to above 30% by 2021, this could result in a near 25% upside to our price estimate (assuming our ASP forecasts remain the same).

Increasing Mix Of Solar Project Sales 

Like most other Tier-1 Chinese solar manufacturers, Trina Solar has been doubling down on its solar projects business in order to drive long-term earnings growth. The company has adopted a strategy of selling most of its overseas projects upon completion, while holding some projects  – mostly in China – on its balance sheet through commercial operations. Trina completed construction of over 337 MW of systems projects during 2014 and sold about 74 MW to third parties. The company plans to connect 700 MW to 750 MW worth of projects to the grid during 2015. Although Trina doesn’t currently break out the results of its projects business, it’s likely to be quite lucrative. The company has indicated that it expects gross margins of above 20% for its overseas project business (projects sold outright) and margins of about 50% for projects in China that it operates to sell electricity. That said, the projects business does come with some challenges, such as identifying suitable land, securing financing for projects at reasonable terms and interfacing with government and other authorities for the requisite approvals, permits and grid connections.

Our current price estimate assumes that Trina’s total capacity sold would increase from about 4.1 GW in 2014 to about 6.2 GW by 2021. We estimate that the blended ASP (systems+standalone modules sales) will increase from about $0.63/watt in 2015 to about $0.71/watt owing to an increasing mix of project sales, which should more than offset a decline in module prices. However, if the company is able to further increase its mix of projects sales by the end of the forecast period, helping it to increase blended ASP to about $0.75/watt, while improving adjusted-gross margins to about 29%, this would increase our price estimate for the stock by about 25%.

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