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China Sunergy


beat the Street in the third quarter, with earnings of 37 cents per share easily beating the Street consensus of 20 cents, and full year models for 2010 may have to go higher as a result. However, with solar investors already looking to 2011, China Sunergy's plans for vertical integration and more visibility on pricing and demand that will drive outlook on the niche Chinese solar play.

Shares of China Sunergy are up 4% on Monday and trading was at three times the level of typical trading volume. Trading of more than 1 million shares at the midday mark on Monday marked an atypical occurrence for China Sunergy, and was pretty volatile, with a big move up at the open, followed by a wiping out of any gain, followed by another rally.

The Chinese solar company has only surpassed the one million share mark a handful of times in the past 6 months. To be clear, the rally in China Sunergy shares is not a major move away from a trading band typical for the Chinese solar company. Rising to $4.80 at midday on Monday, China Sunergy shares were merely at a share price at which they had been a few weeks ago.

Even if short-term trading has been in a narrow band, a sign that investors are may be looking past the short-term time horizon is that China Sunergy guided gross margin down for the fourth quarter, to a range of 15% to 16.5%. Gross margin had ticked up slightly in the third quarter to 19.9% from 19.8% in the previous quarter.

Guiding for a gross margin decline is an earnings tell that typically sinks solar shares. In the case of China Sunergy, however, investors would have already been expecting higher wafer costs to hurt margins. Wafer costs increased in the third quarter by 5 cents per watt, and the fourth quarter is expected to be the peak in wafer pricing.

China Sunergy management said on its earnings conference call that wafer pricing will be up 12% to 15% in the fourth quarter, and then come down by 5% to 10% in the first quarter of the new year. From the third quarter to the end of the first quarter 2011, wafer prices should be slightly higher, and the fourth quarter will exact the biggest hit on margins.

Investors may be giving China Sunergy a bit of a pass on the short-term wafer supply constriction and the one-quarter hit to gross margin.

China Sunergy made the case in its earnings conference call that it will continue to pursue vertical integration and increase the focus on branding its own modules, moving away from the OEM business. The company stressed that the OEM business is slated to become a very minor part of its sales in 2011. While the move away from private label business and the move to branding the CSUN name should result in more spending, the economics of vertical integration in solar could be the most important trend for this company.

China Sunergy said on the earnings conference call that after the gross margin dip in the fourth quarter, it expects margins to move up again as its generates lower costs through its production ramp and vertical integration.

The Chinese cell and module maker expects 95% of its cell business in 2011 to be reserved for its own modules. This trend is reflected in the recent numbers. Cells accounted for 93% of revenue in the third quarter. The Chinese solar company noted that 74% of all sales in the third quarter were to related parties. China Sunergy acquired two module makers during the quarter. Notably, the 74% of sales being routed to its captive sales channel increased from 63% in the previous quarter.

The story, and the questions, haven't really changed for China Sunergy. For a company transitioning from being a solar cell maker to a vertically integrated Chinese solar company, the logic is strong but the execution is always an issue. With 95% of cell sales slated for its own module production, China Sunergy has a different set of competitors now and a different route to market.

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The company will still have to prove how much costs savings it can engineer through vertical integration. Additionally, average selling prices in solar and raw material prices will play into its vertical integration model. While the roadmap presented by China Sunergy in its third quarter earnings conference call was clear, it's still going to come down to where all the costs meet in the middle amid its transition to a vertically integrated maker of solar modules.

As in most calls this earnings season, the discussion between China Sunergy and the Street came down to pricing and demand outlook in 2011. Here are some highlights from the China Sunergy commentary.

On cell pricing and volume:

The solar cell average sales price will be slightly higher in the fourth quarter, but down in 2011, management said. The company will reach 750 MW in cell capacity in 2011. The more important point for the company was that 95% of cells would be going into its own module shipments.

On module pricing and volume:

For 2011, China Sunergy had 500 MW of module contracts signed by the end of last week, 20% of which will be at fixed pricing. Another 120MW in 2011 module sales is expected before the end of the year. The important point here, consistent with the lack of visibility in the solar market, is that 80% of China Sunergy's 2011 contracts are still at pricing that's subject to quarterly adjustments, and the company wouldn't disclose pricing on the 20% of contracts already signed at fixed pricing.

The company did indicate that it expects solar module average sales price to decline in the high single digits, to the range of $1.75, or slightly higher, in the first quarter of 2011. Current module pricing is $1.95 in the third quarter, and the company expects module pricing to be flat in the fourth quarter. China Sunergy expects to reach 1.2GW of module capacity by the end of 2011.

On wafer pricing and volume:

In the fourth quarter, wafer pricing will be up 12% to 15%, from 88 cents/watt in the third quarter, and then down 5% to 10% in the first quarter 2011. China Sunergy said it doesn't have any plans to bring additional wafering capacity in-house in 2011.

On geographic diversification:

Italy represented 29% of sales in the third quarter. Sales into France were 15%, Eastern Europe 14%, Germany 13%, and the U.S. 10% of sales. In Eastern Europe, sales were split between the Czech Republic, Slovakia and Bulgaria.

-- Written by Eric Rosenbaum from New York.


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