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CSIQ's Reputation: A Weakened Currency?

Canadian Solar's stock price takes a hit on Wednesday, but the damage to its credibility may be even greater.

(Canadian Solar story updated for Thursday market action and analysis)



) -- Street frustration with corporate management often takes the form of pithy titles given to negative research reports, and the solar industry was no exception on Wednesday.

This was the case with the Macquarie Securities view of

Canadian Solar

(CSIQ) - Get Canadian Solar Inc. Report

, as Canadian Solar shares fell 15% on Wednesday after pre-reporting weaker-than-expected gross margins for the first half of 2010.

Macquarie Securities' analyst Kelly Dougherty titled her Canadian Solar report, "Oops They Did it Again," a rare moment of convergence between solar stock earnings surprises and pop star Britney Spears.

The bleeding in Canadian Solar's share price was continuing in Thursday's trading session. Canadian Solar share losses were at 3% in the afternoon on Thursday, after the 15% share decline on Wednesday.

Thursday share decline brought Canadian Solar's trading price below $18 intraday -- the first time that CSIQ shares have dipped below the $18 mark since last November.

Canadian Solar had the biggest loss in the solar sector for the second consecutive day on Thursday, and it was bringing many stocks in the solar sector down alongside it.

What exactly did Canadian Solar do to merit the share price implosion, the mocking reference to Britney, as well as a downgrade from Macquarie to neutral, and a price target drop from $35 to $23?

For the second consecutive quarter, Canadian Solar surprised the market with a pre-earnings announcement that gross margins would disappoint.

Last quarter, it was

a problem with Canadian Solar's ingot furnaces, which the solar company said would be the cause of a gross margin shortfall.

Late on Tuesday,

Canadian Solar said that a foreign exchange loss of as high as $20 million would be an unexpected cause for a gross margin shortfall in the first quarter.

For Macquarie Securities, though, the real "oops" is that Canadian Solar exacted another hit on its own reputation, and Macquarie seems inclined to keep the company on a short leash.

Macquarie was to the point in its written comments about the latest misstep from Canadian Solar, writing, "After two consecutive quarters of negative preannouncements (despite very strong demand), we believe CSIQ's management has really damaged its credibility... We believe damaged credibility will be a difficult issue for CSIQ to overcome."

Macquarie said the reputation damage was the primary reason for the downgrade from buy to neutral.

What's more, Macquarie instructed investors that between

Trina Solar



JA Solar


, there is no reason for investors to take any risks on Canadian Solar.

Macquarie's take wasn't the only recent negative turn on Canadian Solar. Auriga Securities was out last week with an initiation of Canadian Solar coverage that

recommended an earnings season short on CSIQ shares.

Collins Stewart also recently

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warned investors that Canadian Solar's gross margins were likely to drop in the second quarter as pricing on the third-party solar cells that it purchases cut into the solar company's margins.

The most troubling issue for Collins Stewart analyst Dan Ries was that he was having a hard time figuring out how Canadian Solar managed to exceed his worst-case scenario for a foreign exchange loss.

Ries has a worst-case foreign currency model for solar earnings that assumes a completely unhedged position. Even that model only calculated a $14 million currency loss for Canadian Solar.

Ries also was frustrated with Canadian Solar for not having provided any warning signs of a currency loss and the impact on average selling price earlier on its guidance. The euro lost more than 6% versus the dollar in the first quarter, a deteriorating currency situation that should not have caught Canadian Solar by surprise.

"The ingot furnace problem had gone on for months and we only found out about it after the fact. Canadian Solar was able to recover from that misstep, yet Canadian Solar has guided improperly again, and you have to wonder if it hurts their credibility. The stock


down 15%," Ries said.

First Solar

(FSLR) - Get First Solar, Inc. Report

is among the only solar companies to provide the Street with a model for the foreign exchange impact on earnings.

Auriga Securities analyst Mark Bachman said the Street should take some of the blame in setting up Canadian Solar for a fall by modeling Canadian Solar's gross margins at 18% -- Bachman thinks it is a 15% gross margin business, regardless of this quarter's woes. "The company was clearly under-hedged and will fight an uphill battle, but the Street has responsibility too for assuming Canadian Solar wasn't a lower teens gross margin business," the Auriga analyst said.

The Auriga analyst was not letting Canadian Solar management off the hook at all. "When a stock loses as much as Canadian Solar has -- CSIQ shares were at $18 on Wednesday afternoon after being above $24 last week -- you're looking at a fourth of market cap getting cut. It's not a positive maneuver for which you can commend management. It shows a lack of financial acumen," Bachman said.

Canadian Solar noted in its Wednesday announcement that it is now 85% hedged. Auriga's Bachman said that the solar company's better-late-than-never move to hedge its currency exposure might have been part of its gross margin shortfall in the first quarter, as it is difficult to estimate how much the company spent on hedging.

"They threw on a ton of hedges, and hopefully we will get more clarity on how they reached a $20 million charge," said Bachman, adding, "looking at 6% change in currency in one quarter won't do it for you."

The Auriga analyst said that most sophisticated firms have more than a one-quarter view of currency exposure and hedge out several quarters. "I don't know how Canadian Solar got to a foreign exchange loss of $20 million in the first quarter, but it could be related to the cost of putting in place the hedges to protect second quarter revenues," Bachman said. The analyst added that it is also possible the ingot furnace problems at the root of last quarter's gross margin shortfall lingered into the first quarter.

Collins Stewart's Ries said about the hedging move by Canadian Solar, "It was too late, but hopefully, the last time it's too late for them."

The problem for the Collins Stewart analyst is that the larger threat for Canadian Solar still looms in the second quarter regardless of its hedging strategy -- its gross margins are expected to take a hit because of high solar cell prices. That's why even if Canadian Solar puts the hedging issue behind it, the solar company guided investors to expect gross margins at the same 13% to 13.5% level in the second quarter.

Cell pricing varies quarter to quarter depending on the supply demand balance in solar. Canadian Solar benefits when demand is weak and its third-party cell purchases are less expensive. Canadian Solar suffers when demand is high -- as it is right now -- as that keeps both solar cell and wafer prices high. Foreign exchange, like cell and wafer pricing, moves up and down on a quarterly basis also.

Yet it was the ups and downs in Canadian Solar's credibility that may have been the bigger issue for the market on Wednesday. Come to think of it, ups and downs in reputation is probably an accurate profile of Britney, too.

-- Reported by Eric Rosenbaum in New York.


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