Who Are The Potential Winners And Losers As China Pushes For Solar Reforms?

The Chinese cabinet said on Wednesday that it will take steps to reform the country’s ailing solar sector by pushing for industry consolidation and modify part of its solar incentive program. The US listed shares of Chinese firms rallied by as much as 17% on the news.

The statement from the Cabinet comes less than a week after the Chinese Finance Ministry and the Ministry of Science and Technology announced separate subsidies to boost domestic demand for solar panels. (See Also: China Boosts Solar Subsidies But Benefits Likely To Be Modest) We believe the reforms are good news for Trina Solar (NYSE: TSL), one of the healthier Chinese solar firms that we cover, while the struggling LDK Solar (NYSE: LDK) could be negatively impacted.

Details of The Reforms And Incentives

The Chinese cabinet will encourage mergers within the industry and could also make it easier for weaker manufacturers to declare bankruptcy. The government also took a tough position on supporting failing solar firms, saying that it will reduce the financial support extended to them and also ban state governments from supporting them. ^[1] China’s state governments have been steadfast in their support of regional solar industry players by bailing them out with emergency loans and funding packages.

The government will also modify the feed-in-tariff system to be region-specific. Feed-in-tariffs (FIT)  provide above market prices for solar generated power to incentivize installations. The FITs are now expected to be based on the level of solar radiation that a region receives, meaning that areas with lower solar radiation could receive a higher feed-in-tariff. The government will also offer value added tax policies for photovoltaic solar projects. (China to Make Regional Adjustments for Solar Power Incentives, Bloomberg)

Why Is It Significant?

Chinese solar firms embarked on a rapid capacity expansion spree beginning 2009, building the world’s largest photovoltaic manufacturing base, funded primarily by cheap debt from state-backed banks. Since global demand growth did not keep pace with the supply expansion, this led to severe overcapacity in the market. Panel prices have declined by more than 30% over the past year. Now, most firms are reeling with low or negative gross margins and are struggling to service their massive debt loads.

Thus far, the government has been supporting the struggling industry by providing loans and taking steps to boost domestic demand for solar products but it hasn’t been particularly effective, given that most of the problems in the industry stem from massive capacity and aggressive pricing  by weak manufacturers. We believe that the recent move to bring about consolidation could have a positive and more far reaching impact on the industry as it attacks the root of the problem.

While the government has not provided specific details on how it intends to execute its plans, it may not be easy. Any move to cut down capacity or shut plants could face opposition from local governments given the large scale employment that solar firms have been providing in their provinces.

What Does This Mean For Solar Companies That We Cover?

Consolidation and bankruptcies within the sector could serve to reduce overall capacity and thereby allow firms better pricing power and improve capacity utilization.  The surviving firms are also likely to benefit from government support and growing demand from the Chinese market.

We believe the move will be positive for Trina Solar given the firm’s relatively strong balance sheet and comparatively better operational performance. As of last quarter, the firm had total debt of around $1.1 billion and an equity position of almost $1 billion. Trina Solar is likely to benefit from consolidation within the industry and could be in a position to acquire weaker solar firms with government assistance.

We believe that LDK Solar could potentially be a acquisition target given the firm’s deteriorating balance sheet position and liquidity crunch. LDK was severely impacted by the industry downturn due to its large scale and vertically integrated operations. The firm has deeply negative cash flows and debt load of around $3 billion (of which $2 billion matures over the next year) while its equity position stands at a mere $30 million. LDK has been trying to shore up its financial position by selling its assets and equity to raise funds, but its bargaining power in these deals has been very weak given the desperate situation it faces. The firm has already cut around 10,000 jobs this year.

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1. China to Promote Solar-Power Consolidation, WSJ [↩]