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Canadian Solar: Margin Pressure is Back

Canadian Solar pre-reports gross margins well below Street expectations, the first negative surprise in what could be another volatile solar earnings season.

(Canadian Solar story updated for analyst action, trading)



) -- Not one solar energy stock earnings report has been released yet, but solar earnings season has begun. Gross margin underperformance and foreign exchange losses -- worries coming into the earnings season -- showed up for the first time last night.

Canadian Solar

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pre-reported gross margins of between 13% and 13.5% for the first quarter, well below Street expectations.

Canadian Solar shares dropped by more than 12% on Wednesday morning and eclipsed its average daily trading volume within an hour of the market open.

The key issue for Canadian Solar is that cell pricing has remained at a higher level than expectations. For solar companies that are not truly integrated and rely on third-party purchase of cells, like Canadian Solar, assumptions had been for lower cell prices in the first quarter.

The true "vertically integrated" solar players, like

Trina Solar



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should not be negatively affected by cell pricing. Wafer pricing has also been stronger than previously anticipated.

Still, analyst Dan Ries of Collins Stewart said the margin pressure, in this case, could not be linked to the larger issue of cell pricing. The Collins Stewart analyst expects that the pricing-related margin pressure will hit Canadian Solar in the second quarter.

Canadian Solar also made clear in its press release announcing the margin shortfall that it was not related to raw materials costs, ruling out cell pricing as a factor.

This statement, however, left analysts scratching their heads as to how Canadian Solar had such a large foreign exchange charge in the quarter.

Canadian Solar said its foreign exchange charge in the first quarter would be $18 million to $20 million.

With all the solar companies flooding Germany with modules ahead of the expected feed-in tariff cuts, forex losses are expected across solar companies. Yet foreign exchange losses or gains always change quarter to quarter.

The Collins Stewart analyst said that the Canadian Solar forex loss, in particular, was concerning in this case because it was at a level higher than even a worst-case scenario, unhedged currency model would explain. Collins Stewart's worst-case model for a foreign exchange loss in the quarter was at $14 million for Canadian Solar.

All solar energy stocks were down on the Canadian Solar surprise pre-earnings report. Trina was down more than 6%, while First Solar and Suntech were down more than between 3% and 4% on Wednesday morning.

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Canadian Solar reported that shipments would be above expectations by as much as 11 megawatts, at a level of 189 MW to 191 MW.

On Tuesday,

Evergreen Solar

also reported record shipments for the first quarter, but analysts cautioned that

Evergreen Solar was cherry-picking good news among another poor gross-margin quarter.

The Canadian Solar margin shortfall was not a complete surprise

. Auriga Securities has recently come out with a short-term negative thesis on Canadian Solar for the reason that the Street was overestimating the Chinese solar company's margins and the solar energy stock would fall upon announcing its actual margin performance.

Auriga had estimated that gross margins for Canadian Solar would be in the range of 14%. The only things Auriga got wrong were the timing of the margin surprise, and giving Canadian Solar more credit than it deserves with a 14% margin level, versus the 13% to 13.5% that the solar company told investors to expect on Wednesday.

Collins Stewart also recently downgraded Canadian Solar on fears about gross margin weakness in the quarter.

Auriga Securities analyst Mark Bachman said on Wednesday morning that he still believes the big issue for Canadian Solar is not the foreign exchange loss, but the overall margin profile of its business.

Macquarie Securities downgraded Canadian Solar shares to neutral on Wednesday morning.

Collins Stewart has now reduced its first-quarter earning per share estimate for Canadian Solar from 37 cents to a loss of one cent.

Canadian Solar also indicated that second quarter gross margin is expected in the 13 to 13.5% range, below Street forecasts, also. Collins Stewart reduced second quarter EPS from 43 cents to 36 cents, and full year earnings from Canadian Solar to $1.29 from $1.72.

Wedbush Securities reduced its price target on Canadian Solar from $22 to $17 and first-quarter earnings estimate from 48 cents to 3 cents.

Gross margin underperformance was the biggest pressure point for solar stocks in fourth-quarter earnings amid record shipment levels and record revenues. It looks like things haven't changed with solar stock first-quarter earnings about to kick off.

Trina Solar reported record gross margins in the fourth quarter, but in providing a more conservative estimate for 2010, Trina's shares were punished after its earnings. First Solar's margin profile -- expected to be on the declining trend in the fourth quarter -- also was met by market displeasure after it showed the erosion largely expected.

Solar stocks have rallied considerably in recent weeks on the unexpected high level of demand exceeding even the most bullish expectations. Some analysts have contended that the rally and the raised estimates from the Street have set up solar stocks for the typical earnings headline surprises and selloff.

The Auriga Securities analyst who downgraded Canadian Solar last week on gross margin concerns, wrote on Wednesday morning that he expects "the disconnect with the Street to be corrected now."

The Canadian Solar and Evergreen Solar pre-reports indicate that investors should have their expectations tempered starting now. Record shipments do not necessarily translate into record earnings performance, and the earnings season ahead could be volatile for solar stocks.

-- Reported by Eric Rosenbaum in New York.


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