Cloudy Skies Forecasted for ReneSola

ReneSola Ltd (NYSE: SOL) admitted on the earnings call that both shipments and realized prices for silicon wafer and modules fell faster than expected in quarter-ending June 30. Contrary to company optimism, gross margin declines will accelerate in coming quarters, as the China-based solar manufacturer has over-promised on expected cost-reduction efforts.

Revenue in the second quarter sequentially decreased 30.6 percent to $249.3 million, while gross margin fell 980 basis points to 18.4 percent. Chief executive officer Xianshou Li blamed a 10.6 percent decline in product shipments (to 295.5 megawatts) on subsidy cuts in key European markets, like Germany and Italy.

Mainland China (including Hong Kong) remains the company’s biggest market for solar wafers (38.4% of total sales) and Europe its top market for wafer sales (with Germany and Italy representing 15% and 5.8 percent of total sales). In the second-quarter, total wafer and module shipments sequentially declined 5.3 percent to 230.5 MW and 26.2 percent to 65 MW.

Lower feed-in-tariffs in European markets, however, belie other economic realities pressuring margins: Exacerbating a demand-driven environment is overcapacity, as mainland competitors flood both domestic and global markets with photovoltaic (PV) products, from crystalline wafers to modules. Supply gluts are accelerating the drop in average selling prices (ASP) quicker than previously estimated: The ASP of solar wafers and modules in the quarter dropped to $0.69 per watt and $1.53 per watt, respectively, compared to ASP of $0.87 and $1.72 in the first quarter.

Already one of the lowest-cost wafer suppliers, the company believes it can stabilize margins and mitigate falling end-demand prices through continued efforts at manufacturing cost reductions. Think again.

The crystalline silicon raw material plus the cost of slicing (the principal input costs in wafer manufacturing) represent more than 50 percent of total module cost. Given a fixed price for the raw silicon, a wafer manufacturer like ReneSola can best drive down costs through various process levers, from material and quality yield improvements to decreases in consumables usage, according to a recent white paper from semiconductor giant Applied Materials (NYSE: AMAT).

Non-silicon wafer processing costs rose two cents in the quarter to 26 cents per watt, which the company attributed to learning curve issues involved with further migration toward its higher-quality (more solar efficient) Virus wafer product. Nonetheless, ReneSola’s chief financial officer, Henry Wang, reaffirmed on the earnings’ call that processing cost would decrease to $0.19 by the end of 2011.

In total, ReneSola is targeting a 25 percent reduction in wafer processing costs, driven principally by reducing consumable costs, such as increasing mix percentage use of recycled slurry and bringing in-house more polysilicon production and wire-saws (which cut the ingots into wafers).

Management’s cost reduction efforts ought be applauded – but not when they’re accompanied by less-than-transparent public posturing. Although the company has been successful in reducing the amount of silicon material required to produce solar electricity, from 6 grams per watt to 5.8 grams, continued process optimization and increased productivity (quality yield) will require additional investments in capital, which the company is neglecting (for sake of short-term margins?).

Due to “continued challenging business conditions,” ReneSola is cutting its capital spending plans for the year to only $270 million, from a previously disclosed $350 million.

Expanding in-house production of polysilicon remains critical to lowering overall manufacturing costs. Although the company lowered in-house production cost to about $40 per kilogram, as compared to approximately $54 per kilogram purchased from third-party suppliers, it still is several years removed from bringing more upstream production in-house.

The company has long promised to expand annual polysilicon production capacity to 8,500 metric tons (from a recent 787MT in second-quarter 2011) at its Sichuan province facility. It can cost more than a billion dollars (according to industry papers) to build a vertically-integrated polysilicon plant (with annual output capacity of 8,500 MT). Deferring critical capital expenditures, combined with expected electrical power shortages on the mainland, makes it difficult to ascertain how ReneSola will attain previously stated raw material output goals.

ReneSola has withdrawn full-year guidance forecasts, too, but with the company remaining captive to supplier polysilicon price, it’s possible that gross margins could fall even further than the 6-8 percent level expected next quarter.

David Phillips