Why We Cut Our Price Estimate For Yingli To $1.20

We are cutting our price estimate for Yingli Green Energy (NYSE:YGE), China’s second largest solar company, from about $2.20 per share to around $1.20, owing to concerns over its high leverage, interest burden and lack of profitability. While bankruptcy may not be imminent for the company, given that it is one of the largest firms in an industry that is favored by the Chinese government, the fate of its common equity holders could be more precarious. In this note, we take a look at the rationale behind our price revision for Yingli’s stock and why we think it remains a high risk play on China’s burgeoning solar market.

Our $1.20 price estimate for Yingli is roughly in line with the current market price.

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Profitability Remains Elusive

While solid demand and smaller declines in ASPs helped most tier-1 Chinese solar players return to quarterly profitability as early as 2013, Yingli still remains unprofitable. Yingli’s manufacturing costs are roughly on par with most large Chinese solar players ($0.48/watt in Q1 2015), but its higher operating costs and meaningfully higher financial leverage have weighed on its bottom line. Additionally, the rate of the company’s manufacturing cost reductions could slowly be leveling off, since a bulk of past cost reductions came from the supply chain (sharp declines in polysilicon prices, for instance) rather than from meaningful operational and technological improvements. Supply chain-related cost reductions may be harder to replicate going forward, as demand rises in the global solar markets.

Yingli has indicated that it intends to reduce operating costs by about 20% year-over-year by restructuring its European operations and by reducing marketing costs, potentially allowing it to return to profitability during the second half of the year – but we wouldn’t count on it, since the company made similar claims last year as well. The markets also seem to think otherwise, with analysts polled by Reuters forecasting a consensus loss of $0.64/share and $0.41/share respectively for FY 2015 and FY 2016.

High-Leverage Impacts Common Shareholders

Yingli’s total debt stood at $2.3 billion at the end of March, while its book equity position has deteriorated to a deficit of about $90 million. The company has been managing its debt obligations by rolling over its current loans, while also servicing some medium-term note payments (a $193 million tranche was paid in May, with two more payments due over the next year or so) by divesting land and through other financing facilities. However, selling real estate may not be a sustainable option, given that China’s property market remains in a downturn and also since much of the company’s land is likely located in Baoding, a third-tier industrial city. ^[1] Yingli’s interest expenses stood at about $163 million in 2014 (almost all cash interest) or about 8% of revenues, and this has been a key factor inhibiting its return to profitability. We believe that the firm will need to raise additional equity to find its way out of a potential debt trap. However, even if Yingli is able to raise additional equity from investors or receive a government bailout, common stockholders and ADS holders are likely to get a raw deal. Considering the low value of the firm’s stock, their equity in the company would be significantly diluted.

Key changes to our valuation model include lower shipments forecasts, given the weaker guidance for FY2015, and lower margins forecasts in outer years. We have also calibrated our operating expense forecasts for the company (related: Key Takeaways From Yingli Green Energy’s Q1 And What Lies Ahead).

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1. UPDATE: How Will Yingli Green Energy Repay Its Debt?, Barrons, May 2015 [↩]