Canadian Solar: It's All About the Outlook

SUZHOU, China ( TheStreet) -- Canadian Solar is rallying on Tuesday, up more than 4% a day ahead of its fourth quarter earnings -- but will the share spike last once Canadian Solar reports?

Canadian Solar shares are still trading significantly lower than a mid-February share price over $24 -- on Tuesday at midday Canadian Solar shares were up by 86 cents to $19.96.

The reason for the slide in Canadian Solar shares is earnings-related. Canadian Solar guided investors to a lower gross margin number than expected in the fourth quarter, due to problems at Canadian Solar's new ingot and wafering plant, which drove up costs while lowering yields.

In effect, Canadian Solar pre-announced earnings when it revealed the plant problems, stating that gross margins would be in the mid-teens, as opposed to high teens, and shipments would come in slightly higher than the expected 128 megawatts (MW) in the fourth quarter, at 138 MW.

Canadian Solar shares dropped by as much as $5 in the time since the damage control-based pre-announcement of earnings.

Canadian Solar's earnings might be the least interesting of this week's solar batch, given that the pre-announcement has taken away the potential for surprise. Suntech Power's ( STP) earnings, expected on Thursday, are considered to be a more important read of the solar outlook, particularly if Suntech provides specific guidance on growth opportunities in China.

Gross margin has been a key factor this earning season for solar companies. Both First Solar ( FSLR) and Trina Solar ( TSL) earnings were met with a less-than-enthusiastic response from the market , at least partially driven by gross margin levels.

In that sense, it might be good that Canadian Solar preempted its gross margin shortfall in the fourth quarter as opposed to waiting for earnings day. Since Canadian Solar has already confessed to its expected gross margin underperformance in the fourth quarter, the earnings are a fait accompli. Still, investors will be looking to Canadian Solar's guidance for 2010, and any indication that the plant problems will continue to impact earnings in the first half of the year.

Canadian Solar already provided 2010 guidance with its third-quarter earnings, and it will be interesting to see if there are any notable changes related to remediating the plant problems, or the more recent developments related to feed-in tariff reductions in Europe, particularly Germany.

In its 2010 guidance issued with the third quarter earnings, Canadian Solar said it expected to grow equally in its biggest markets in 2010, including Germany, where the biggest solar tariff reductions are coming in the second half of the year.

Canadian Solar estimated 2010 shipments in the range of 600 MW to 700 MW, and an increase in solar module production to 1 gigawatt by April 2010. Most notably, given the plant problems, is that Canadian Solar said it expected to increase its internal solar cell production capacity from 420 MW to 700 MW by June 2010. Canadian Solar estimated that it would produce approximately 450 MW to 500 MW of solar cells internally.

"By achieving a higher ratio of internal cell production compared to external sourcing, we expect to sustain gross margins in the high teens and maintain a healthy net profit margin," Canadian Solar stated.

Therein lies the rub: if producing the higher ratio of cells internally is hampered by the plant production problems.

How good has Canadian Solar' previous year-ahead guidance been? Canadian Solar predicted with its fourth quarter 2008 earnings that full year 2009 revenues would be in the range of $600 million to $800 million on shipments of 300 MW to 350 MW.

In the first three quarters of 2009, Canadian Solar has generated revenues of $376.8 million and shipped 168.8 MW.

By the time Canadian Solar's third quarter 2009 earnings came around, the company reduced its shipment estimate to a high end of 305 MW, as opposed to the previous guidance low-end of 300 MW.

There's certainly a grain of salt to be taken with first quarter earnings reports that attempt to have visibility for an entire year. This is the case with Canadian Solar, as it is with all solar companies -- whether it is a year like 2009, marked by the financial crisis, or a year like 2010, expected to be uncertain given the feed-in tariff changes.

Still, Canadian Solar will more or less report accurately on shipments for the year based on its previous guidance.

Canadian Solar won't come anywhere near its revenue high-end target of $800 million for 2009, though. The street expects $267 million in revenues in the fourth quarter and $645 million in revenues for the full year 2009.

Ultimately, Canadian Solar's earlier $800 million revenue hope is now a distant hope, and solar investors may be well-advised to keep any high-end revenue guidance for 2010 at a safe distance also.

-- Reported by Eric Rosenbaum in New York.

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