NEW YORK (TheStreet) -- We begin our dissection of the top stocks in the solar sector with the one that's wreaking the most havoc with the markets this week: Trina Solar (TSL) . Indeed, some solar investors and solar analysts disagree with the reaction on Wednesday to Trina Solar's earnings.
Trina's stock was down by more than 6% on Wednesday, with
investor uncertainty about a deterioration in gross margins in the first quarter serving as one negative data point.
Trina bulls, however, believe the gross margins argument is bull. Trina has a history of conservative gross-margin guidance and will likely outperform the first quarter guidance, as it outperformed the gross-margin guidance for the fourth quarter. Collins Stewart made this point in its research note after the Trina earnings, referring to Trina's gross margin guidance of 26% to 28% as conservative.
Piper Jaffray made the case that gross margins aren't even the best way to think about the Trina outlook. Piper Jaffray analyst Jesse Pichel wrote that the sequential decline of gross should not be a concern because investors have always been expecting commoditization and low gross margin evidenced by a low PE ratio. The higher-than-expected fourth quarter average sales price ($1.91 versus a Piper Jaffray estimate of $1.85) was the result of the third quarter being sold out. Thus fourth quarter gross margins should not be used as a benchmark.
Trina management was asked about the gross margin issue on the Wednesday earnings conference call. Terry Wang, Trina's CFO, said the 32% gross margin in the fourth quarter was a record for Trina, and the company has always maintained that sustainable margins are in the high 20s.
Trina says it is just being prudent, with an average sales price drop of 5% to 10% expected in the first quarter, the depreciation in the euro since the beginning of the year -- Trina noted on the call that it has 90% of its sales in euros. Trina's CFO said the company believes there is upside to that gross margin estimate too. Indeed, on Thursday morning Trina's rebounded, helped at least in part by a Deutsche Bank upgrade on Trina and other Chinese names.
Of course, Trina's share price rose by a full one-third from the third quarter through the beginning of 2010. Maybe given the prudent outlook from Trina management, some investors decided that after a record quarter -- and with uncertainty lingering about solar in 2010 -- this was a good time to book profits.
Trina is still at a share price above where it was after third quarter earnings, and analysts like Adam Krop at Ardour Capital Management said on Wednesday they didn't see how Trina could deliver another quarter like the fourth quarter of 2009. Overall, though, the earnings message from Trina was mixed. The weak first and second quarters from 2009 still lead Ardour Capital to estimate 20% earnings growth for Trina in 2010, even with a second half of the year drop.
Jesse Pichel, an analyst with Piper Jaffray, said investors have always known that Trina is in a commodity business, and the argument as the market becomes more commoditized -- and margins come down -- should be about which companies are the best positioned, an argument which he believes Trina wins. "In my six years of covering renewable energy, I've never seen the sentiment around solar as negative,' Pichel said.
The same negative market take on a solar earnings beat played out after
reported last Thursday.
Gross margin deterioration of 9.4% in the fourth quarter -- a trend that should have been predicted by investors as First Solar moves to a lower margin systems business orientation -- played a role in sending First Solar shares down after its earnings beat.
This negative turn on First Solar was before the news even broke that
Germany was leaning towards eliminating the farmland-based solar projects where First Solar has been a leader.
First Solar also decided to stick with its guidance from mid-December, which already had some analysts on the fence about the stock.
First Solar was nearing a 52-week low on Thursday morning, slipping under the $102 level. The fact that First Solar's former CEO Michael Ahearn sold more than 40% of his First Solar holdings, or $142 million worth of First Solar stock, on Thursday at an average price of $109.50, will not provide more confidence to shares of First Solar coming back from near the 52 week-low mark.
Conservative gross-margin guidance from Trina and First Solar's decision to not up its guidance could be seen on the surface as a penalty being meted out by the market to these solar companies being conservative.
In reality though, the uncertainty in solar goes well beyond any one earnings positive or negative data point, and negative data points may win out at a time when the uncertainty about solar is at a level that reaches higher than quarter-to-quarter earnings.
Andrew Kinross, a director with
said the extent of the uncertainty is now unlike at any other juncture in the -- albeit short -- history of the solar industry.
"For five years this industry has been growing at 40%, and if you'd asked me in any year previous to this year what the next year would look like, the story was a growth one. More incentive schemes were coming in and the costs were lining up. However, at this point, if you attempt to look out over the next few years, it's hard to tell if solar will grow 40% or decline by a significant amount, or if it will be flat. There is just too much uncertainty to answer that question," Kinross said.
In its earnings presentation for investors, First Solar notably included a chart that showed its balance sheet strength versus the balance sheet of its main competitors. It was a self-serving slide -- First Solar's balance sheet versus the combined balanced sheet of its competitors looks like a comparison of a pool of subprime mortgages versus
Still, the fact that the First Solar slide was included does get to one of the core arguments related to the uncertainty in solar. Among all the earnings noise, solar survival will come back to having a captive audience for solar product, a balance sheet that is stable and a cost and technology advantage. Barclays Capital wrote a solar outlook piece this week saying that survival will ultimately come down to these basic drivers.
When it comes to the cost and technology issue,
has short-term issues that will be important points for discussion when it reports on March 3. Analysts that have modeled the impact of the euro deterioration on Chinese solar company shares say it's possible for the foreign currency risk to play an outsize role, since these Chinese solar companies' success is predicated on running a lean operation. It will be important for investors to pay attention to what Canadian Solar has to say about how it is hedging its foreign currency exposure.
What's more, in the case of Canadian Solar, the company announced just ahead of earnings that it had a manufacturing problem at its new ingot and wafering plant that would cause its gross margins to go down from the high teens to the low teens in the fourth quarter earnings.
The ingot and wafering plant is a new effort by Canadian Solar to control more of the solar chain, and circles back around to two of the most important business drivers as outlined by Barclays: a captive audience for product, and cost and technology.
While Canadian Solar said at last week's Piper Jaffray clean-tech conference that two furnaces have been fixed, it said another 18 furnaces are still to be fixed in the first quarter. Canadian Solar said at the Piper Jaffray conference that average sales price will come down from $1.85-$190 to $1.50 by the fourth quarter.
With the pricing headwinds in solar, and Canadian Solar's earnings power already based on its low-cost operations, investors should be on the lookout for any indications of a lingering remediation effort with the ingot and wafering plant, as opposed to a one-time event.
Yingli Green Energy
has been on the same vertical integration plan as Canadian Solar, and undertook the construction of a big polysilicon plant in the U.S. The lead time in spending on the plant's construction, while waiting for the plant to start producing at full capacity, led to a recent downgrade on Yingli from Ardour Capital.
An update on the plant's progress from Yingli Green Energy could be more helpful to investors than fourth quarter earnings numbers, as the plant has the potential to be a drag on earnings, similar to fears that Canadian Solar's furnace issues could linger in 2010.
Barclays Capital joined Ardour Capital in its concerns about the Yingli expansion earlier this week, downgrading the stock from overweight to evenweight. Barclays cited "potential concerns related to poly capacity expansion and associated depreciation expense" increase limiting Yingli's share performance. "Currency risks and potential dilution to fund capacity expansion" may also remain a near-term overhang on the shares," Barclays wrote. Barclays also reduced its target price on Yingli from $19 to $11.
It is safe to say there is a good deal of earnings season noise that doesn't have to do with the actual fourth-quarter earnings numbers.
is a good example of the noise. SunPower hasn't yet made any noise, in fact, in terms of saying when it will report, other than to advise investors it will be some time in March.
Based on previous history, SunPower would have reported already this quarter. Of course, First Solar is expected to deliver a full report on its internal accounting review with this earnings, and it may be simply taking every minute available to it to make sure it has dotted every 'I' in investigation and crossed every 't' in thorough.
Yet while SunPower hasn't made any noise about its earnings date, it made recent noise about the future direction of solar when it
acquired European project developer SunRay for its pipeline of large-scale projects.
The First Solar earnings showed that, as expected, the systems business is a drag on gross margins.
MEMC Electronic Materials
shares were also dragged down after its earnings, when it provided its first discussion of plans to integrate systems-based acquisition SunEdison. MEMC shares have been trading near a 52-week low since the earnings.
While the focus has been on the SunPower accounting investigation for months, the purchase of SunRay may be more important to the quickly changing nature of solar, and it's another sign of all the earnings season noise amidst a larger outlook for solar that is ruled by uncertainty.
In discussion of First Solar and Trina Solar earnings, there has been more discussion of the commoditization of solar and solar companies being "energy product" companies. This is significant, since the profile of solar has always been aligned with growth technology.
Ultimately, the solar outlook may not have as much to do with quarter-to-quarter gross margins as with the margin of error in current estimates for how quickly and completely changes in the market of Germany will push solar in the direction of the large-based solar business in newer markets like the U.S. and China.
As part of its draft legislation revealed on Monday of this week, Germany for the first time put an exact number on how large it wants to see the solar market grow over the next 20 years.
Germany placed a target on its solar market of 66 gigawatts by 2030. This was a significant indication from Germany that it is thinking about a cap on solar. It's not a hard cap, and it's only the first signs of a potential soft cap on solar.
However, most street estimates for the German markets growth over the next few decades assume an annual level above 3GW per year. Gordon Johnson, analyst at Hapoalim Securities, and known as one of the most bearish analyst on solar, noted that even his estimate for Germany is above the 3GW mark. With the 66GW target for total solar capacity by 2030, the annual rate of solar installation in Germany would have to come in under 3GW.
Analysts view this long-term target of 66GW as potentially the most important of all steps being taken by Germany to reduce its feed-in tariff scheme if it is the handwriting on the wall of an eventual hard cap on the German market.
Navigant Consulting director Andrew Kinross said the 66GW target is a significant discussion being started by Germany, but at this point, is no more than that. Placing a 66GW target on the German market by 2030 is the most long-range example of the uncertainty that is dominating in solar this earnings season.
While arguments over gross margins have received the attention in First Solar and Trina Solar earnings, Kinross said it is the margin of error that solar investors should keep in mind when thinking about solar's future.
"We've done 20-year forecasts, but the error bar on them is so high. We don't like to go out more than five years," Kinross said. "Germany has put a number down on paper to give itself some perspective, but the reality is that those numbers can change quite a bit over the course of 20 years," Kinross added.
What the global solar market will look like in 20 years may be an impossible question to answer, when solar can't even seem to reach consensus on the second half of 2010 and 2011. Still, Navigant's Kinross provided a dose of earnings season calm amidst all the noise about gross margins, average sales price deterioration and the commoditization of solar.
"While it's hard to tell what shape the solar sector will take over the next few years, companies will weather the storm. First Solar will be here, and so will Suntech, Yingli, and Trina. They are the cost leaders. "
-- Reported by Eric Rosenbaum in New York.
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