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PDFThe giant solar company needed major help from a notorious related-party deal, first scrutinized in detail by TheStreetSweeper six months ago, just to post third-quarter profits that even approached Wall Street expectations. Technically, the company reported a profit of 18 cents a share that fell a full nickel short of the consensus estimate. However, critics note, without the generous new value assigned to solar projects recently completed by the Global Solar Fund (GSR) – a firm 97% owned by Suntech and its CEO – the company would have generated a much tinier profit of just 6 cents a share instead.
Axiom Capital analyst Gordon Johnson, a longtime Suntech bear, refused to include that handy benefit in the company’s results when reiterating his latest call for investors to sell the volatile stock. Johnson presented a compelling argument, as summarized below, while stating his case against the company.
After Suntech’s majority-owned GSF completed 10 megawatts worth of solar projects in the third quarter, Johnson noted, the company suddenly decided to increase the “fair value” of its GSF investment by $19.8 million and add a hefty 12-cent gain to its bottom line. When calculating that profit estimate, Johnson said, Suntech assumed that the company would be able to charge $6.84 per watt for those GSF solar plants when – and if – it actually manages to sell them. However, Johnson emphasized, a rival company collected just $5.40 per watt for a solar plant it sold last quarter in the same European market where GSF will be pitching its own plants.
Chances are, Johnson suggested, Suntech may not even secure that lower $5.40/watt price for its GSF projects. After all, he noted, Suntech is peddling those plants in an Italian market that – beginning Dec. 1 – will see a 6% cut in the so-called “feed-in tariffs” that subsidize the country’s solar industry. As a result, he predicted, Suntech faces little chance of realizing the generous value now placed on its GSF power plants.
Meanwhile, Suntech itself is forecasting even bigger gains on larger GSF projects that will soon reach completion and become available for sale next year.
“We assign a greater-than-80% probability that the price at which STP sells GSF plants at in 2011 – or whenever it sells the plants, if indeed it can find a buyer – will be materially below the $6.84/watt the company apparently ‘marked-to-model’ this quarter,” Johnson wrote the day after Suntech posted its latest results. “When – not if – this happens, in our view, STP will have to take a loss on the ‘Equity in Affiliate Earnings’ line …
“As this dynamic becomes better understood,” he continued, “we believe STP’s valuation multiple will compress.”
While Suntech tumbled almost 10% on news of its reported results, Johnson predicted that the stock would have “fallen MUCH more” without the company’s latest accounting trick. As a result, he urged investors to sell Suntech even after that big plunge. He estimated the true value of the stock -- which has plummeted almost 30% from $10.62 to $7.48 since TheStreetSweeper first examined the company -- at just $6 a share.
According to disclosures in his latest Suntech report, Johnson has no financial position in the company’s stock.
When It Rains, It Pours
Other experts have taken a cautious stand on Suntech as well. Credit Suisse analyst Satya Kumar downgraded most of the solar sector last week, Barron’s reported, cutting four stocks to neutral and two stocks – including Suntech – to underperform due to concerns about a perceived “supply gut” in the industry. Meanwhile, although Macquarie analyst Kelly Dougherty continues to maintain his neutral rating on Suntech, even he has been steering potential investors away from the company.
Like Johnson, Dougherty noted that Suntech’s third-quarter results would have looked “even uglier” without the reported non-cash gain from its GSF deal. He voiced serious concerns about Suntech’s expensive cost structure, too. During the recent period, he noted, Suntech shelled out higher prices for solar wafers – pushing the company to pay a hefty premium for wafer capacity of its own – even as it collected lower prices for its own finished products. As a result, he added, Suntech posted weaker margins that remain well below those enjoyed by most of its peers.
“STP’s 3Q10 results were disappointing, its new wafer strategy will be expensive, and we still aren’t comfortable with some of its accounting,” Dougherty wrote last week. “There are just too many moving parts to the story, so we expect the stock will continue to underperform our universe.”
Therefore, Dougherty recommended other Chinese solar stocks – such as ReneSola (NYSE: SOL), Trina Solar (NYSE: TSL), JA Solar Holdings (Nasdaq: JASO) and Solarfun Power Holdings (Nasdaq: SOLF) – as better picks instead. His firm reported no financial conflicts, related to any of those stocks, in the disclosure section of its website.
Meanwhile, Johnson offered a more detailed review of Suntech’s high-cost wafer strategy. With its recent $207 million purchase of a 70% stake in a wafer production plant, Johnson calculated, Suntech paid roughly 79 cents a watt for its new wafer capacity. However, he predicted, conservative estimates suggest that solar wafers will soon fall by at least 30% and be selling for no more than 60 cents a watt instead.
Others, including Kumar, clearly worry that Suntech paid too much for that wafer capacity – and could, therefore, remain at a cost disadvantage to its peers – as well.
“The question that a lot of investors are asking me, and I have as well, is (about) the price you’re paying for this wafer capacity,” Kumar stated in a recent conference call transcript supplied by Seeking Alpha. “It appears that the capacity is being purchased at 79 cents per watt. And you’re saying that you can add new capacity at 40 cents, and there some companies saying they can add new capacity at 20 cents.
“Could you help us understand why the price paid for this capacity is significantly higher than market price to add new capacity?”
To critics like Johnson, management’s explanation – a vague response that “time is (of the) essence” – failed to address the issue at hand.
Suntech leaders never answered a simple question about the company’s operating cash flow, either. Instead, the CFO chose to tout Suntech’s improved cash position while attributing that progress to solid management of the company’s working capital.
But Johnson, for one, saw other – less impressive – factors at work instead.
“A closer look at STP’s balance sheet reveals that excluding the $388 million in cash generated by quarter-to-quarter shifts in other current liabilities … operating cash flow would have been negative by $137.1 million,” he observed. “While we acknowledge that current liabilities are indeed a contributing factor to operating cash flow, management’s focus on the call centered on its solid management of accounts receivable and inventory – both of which actually contributed to cash burn, NOT cash generation.
“Thus, before we are willing to concede that STP is indeed managing working capital efficiently,” he concluded, “we would like to see: 1) better management of inventory and accounts receivable and 2) concise answers when asked about what the operating cash flow was for the quarter.
“We still have yet to see this from STP.”
* Note: No member of TheStreetSweeper’s staff or advisory board has ever taken a financial position in Suntech (STP) or received any compensation from others who have positions in the stock. As editor of the site, Melissa Davis will never take a position in any of the stocks that she covers. To contact Ms. Davis, the author of this story, please send an email to editor@thestreetsweeper.org.
