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Solarfun (SOLF) has problems

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tumb_SOLF_6_4_1Solarfun (NASDAQ:SOLF) published a sound Q2 report on August 27. By June 2008, Solarfun reported revenue to reach $197.1 million, representing an increase by 12.7% on quarter-over-quarter (QoQ) basis and 192.2% on year-over-year (YoY) basis. Behind basic numbers lies a story of a company that doesn’t generate enough cash to fund operations, has no long-term poly silicone supply agreement and is exposed to spot prices. Given Solarfun’s relative small market capitalization and subdued R&D spending, we have doubts about the long-term performance of her ADRs .

Global economic recession and high inflation

Following economic downturn in America growth perspective for the global economy is dim.  Although the Federal Reserve announced plans for a major cash infusion to clean up balance sheets of troubled companies, increasing price of crude oil and high inflation in China together bring investors worries. Under such circumstances, we recommend investors to be more on the defense and avoiding risky assets.

 

Estimates:

 

SALES (in millions)

EARNINGS (per share)

Quarter Ending Sep-08

1784

0.44

Quarter Ending Dec-08

2356

0.59

Year Ending Dec-08

3110

0.77

Year Ending Dec-09

9441

2.35

High tech Company with high growing rate

As high technology company and provider of necessary part for re-generating energy equipment, Solarfun has high growing rate which is the same nature as other similar companies. Furthermore, Solarfun currently displays significant financial feature of starting its expansion. For the investors who interested in risking for high return, we recommend to include this stock into portfolio to enjoy star light in the dark sky.

1. Earnings suffer great loss due to increased G&A expense and low investment return

Solarfun suffered earning loss in the second quarter 2008 by 25%, compared to earnings in the first quarter. Basing on the common size analysis on company’s 3 month income statements, this loss mainly comes from the increase in G&A expense and huge loss from long term investment.

G&A increased by 0.9% from quarter one as a percentage of total revenue. As what is shown below, this increase, according to the analysis, is normal and acceptable. At first, revenue increased accompanied with the need of more cost; secondly, the percentage level is still in normal range which could be referred to corresponding number in 2007; thirdly, company enhanced vertical management which may lead to more  coordinating expenses; at last, series demand and supply contracts have been signed during this quarter. These negotiations could have incurred necessary cost.

Interest expense does not put significant burden to company’s financial status, whereas company’s long term investment suffered huge loss because of unfavorable movement in global economy, especially the shock in Chinese stock markets.

All these factors together influence solarfun’s quarterly record, although sound revenue had been created.

Operating Cost Structure

 

2008 Q2

2008 Q1

2007 Q4

2007 Q3

2007 Q2

Total Revenue

100.0%

100.0%

100.0%

100.0%

100.0%

Selling/General/Admin. Expenses, Total

4.5%

3.6%

7.4%

6.5%

6.9%

Research & Development

0.6%

0.4%

0.9%

0.4%

2.2%

Other Operating Expenses, Total

0.1%

0.9%

0.8%

0.1%

-0.4%

 

Total Operating Expense

93.2%

89.4%

93.1%

91.5%

95.3%

 

 

2008 Q2

2008 Q1

2007 Q4

2007 Q3

2007 Q2

Total Debt

100.0%

100.0%

100.0%

100.0%

100.0%

Interest Expense, Net - Operating

2.2%

2.3%

1.2%

0.9%

1.1%

 

 

2008 Q2

2008 Q1

2007 Q4

Long Term Inv. & Ass., Total

100.0%

100.0%

100.0%

Interest/Investment Income - Operating

2.7%

10.6%

-2.3%

 

2. U.S economic rebound and high oil price offer growing opportunity for solar industry

On 31st August 2008, American economy allegedly had achieved 3.3% increase in the second quarter, which is much greater than its growth for the first quarter that only 0.9%. Moreover, given rigorous fuel consumption in current worldwide industries and day-after-day increasing petrol price, re-generating energy faces great opportunity to increase market share. From our viewpoint, the up trend for crude oil price is inevitable, which also depends our analysis on other factors including high inflation in global economy and the oil shortage which seemed fails to feed current industry consumption. Under such circumstance, re-generating energy industry will be given good developing opportunity.

3. Low price developing strategy is applicable

According to company’s Q2 report, its average selling price during the second quarter of 2008 improved to $4.17 per watt from $4.07 per watt in the first quarter. Solarfun, however, warned average selling price is expected to decline 5 percent to 10 percent from expected fiscal 2008 price. This prediction led to shares price dropped by $1.52 to $17.42 on the date Q2 report released. According to our analysis, decline in price is applicable. It may benefit from company’s vertical management which brings down raw material expenditure. Moreover, that behind it probably is the low cost strategy used for winning larger market share.

4. Sound performance and growth rate compared with industry average level

As producer of high technology silicon ingots, Solarfun grows following with high technology industry.

Compared with industry average level, Solarfun display fantastic performance and growth rate. Its P/E ratio exceeds industry average level by over 100% and this outstanding advantage leads its sound return on assets and equity. Besides, Solarfun’s profitability margins are obviously higher than almost other solar companies.

SOLF_6_4_1

5. Undervalued performance offers market with good expectation

Compared with Suntech Power Holdings Company Ltd (Suntech) which is regarded as top-ranked solar company and operate similar business as Solarfun, Solarfun also displays strong momentum for future development. Considering Market Capital/Total Assets ratio for these two competitors, Solarfun and Suntech are 1.00 and 2.68 respectively. Specifically, Suntech’s market capital is 9.64 times more than Solarfun’s whereas total assets are only greater at 3.64 times. By 30th June 2008, Solarfun achieved 192.20% growth rate on revenue while Suntech grew at 51.30%. Currently, although Solarfun’s P/E and P/S ratios are far lower than Suntech’s, Solarfun’s 5-year growth rate for P/E ratio indicates its great momentum for its stock price. Given the same industry environment, it is reasonable to believe that Solarfun has been undervalued by market and its predictable future performance is optimistic.

Solarfun

Suntech

P/E (ttm):

17.59

37.26

P/S (ttm):

1.23

4.21

PEG (5 yr expected):

0.73

0.71

Qtrly Rev Growth (yoy):

192.20%

51.30%

Gross Margin (ttm):

15.61%

22.07%

Oper Margins (ttm):

9.75%

14.48%

 

 

 

 

 

 

 

 

 

 

 

6. Cash components analysis indicates company is facing in liquidity shortage

In 2007, Solarfun experienced a big drop on operation cash flow and this led to insufficient liquidity by the end of 2007. Current ratio in 2007 is only 2.62, lower than industry average level at 3.67. The main reason for this problem is significant increase in working capital, which is still the case in the first and second quarters in 2008. However, in 2008, company adjusts the structure of working capital. In the last quarter 2007, company’s inventory increased by 39.3% which accounts for most working capital increase.

In the first two quarters in 2008, inventory has been controlled to be built up at 5%~7% while cash and cash equivalent increased over 100% compared with that in 2007. By examining the components of cash flows, we conclude that Solarfun currently is facing liquidity shortage. In 2008 SOLF issues 5 million plus ADRs to cash in $72 million which is further evidence to warn liquidity problem. In the second quarter report 2008, SOLF also alleged it would improve working capital management. Although company up to now have not shown embarrass to cash position, its long term adverse effect should not be ignored.

Cash Position changes (YoY)

SOLF_6_4_2

7. Vertically management is going to be enhanced with the objective of meeting capacity expansion

Solarfun was established as an integrated manufacturer of silicon ingots and photovoltaic cells and modules in China. Currently, its production scale just ranks the fourth position among China solar companies. In order to expand its capacity successfully, company chooses to make full use of its advantage in vertical management in the coming one year. In the second quarter of 2008, Solarfun has signed an 8-year, 1.2 gigwatt (“GW”) contract for virgin polysilicon with GCL Silicon Technology. Besides, company announces to sign a series of sales contracts to guarantee market demand for the PV: sales contracts have been signed with Schuco International KG and Martifer Solar Sistemas Solares, contingent sales of PV which is in form of letter-of-intent (“LOI”) has also been settled down with Q-Cells AG. These documents guarantee company’s operation with at least 8-year reliable raw material supply and 3-year PV market demand.

Company aims to expand PV capacity depending on its high growing profitability and working capital support. After half year expanding rate at about 12% for PPE, by the end of second quarter 2008, Solarfun once again realized increase in PPE at 32% on QoQ basis, which is the same rate as that in the third quarter 2007. With steady increase in revenue, it is possible for company to sustain high growing rate in 2008.

8. High growth rate in revenue does not create corresponding competent profit margin. Internal management needs improvement

Compared with company’s revenue boom, operating margin and gross margin do not perform corresponding remarkable result. This may due to the decrease in earnings. As what mentioned above, G&A expenses increase significantly in Q2, which indicates Solarfun need further improve on its operating management. Company has been endeavoring guarantee reliable raw material supply and focus on market demand, but neglects internal operating procedure. Obviously, internal management could be the point to concern when we consider this stock.

SOLF_6_4_3

Balance Sheet

In Millions of Renminbi
(except for per share items)

2008
2008-06-30

2008
2008-03-31

2007
2007-12-31

2007
2007-09-30

2007
2007-06-30

 

 

 

 

 

 

Cash and Short Term Investments

557.7

595.2

272.9

345.4

447.9

Total Receivables, Net

461.7

654.5

431.6

684.9

360.3

Total Inventory

823.4

780.9

728.5

523.0

411.3

Other Current Assets, Total

1,870.6

1,750.5

899.9

776.3

512.2

Total Current Assets

3,713.5

3,781.0

2,332.9

2,329.6

1,731.9

 

 

 

 

 

 

Property/Plant/Equipment, Total - Net

1,134.3

857.6

702.9

525.9

397.8

Intangibles, Net

93.3

93.8

94.3

161.3

12.8

Long Term Investments

5.1

5.2

5.1

0.3

0.3

Other Long Term Assets, Total

195.1

200.0

214.4

--

--

Total Assets

5,141.3

4,937.7

3,349.5

3,017.1

2,142.7

 

 

 

 

 

 

Accounts Payable

181.3

209.8

234.4

165.4

136.1

Accrued Expenses

140.4

140.5

135.4

71.5

44.8

Notes Payable/Short Term Debt

1,078.9

988.1

965.0

757.9

217.8

Current Port. of LT Debt/Capital Leases

22.0

15.0

15.0

16.0

16.0

Other Current liabilities, Total

77.6

91.3

27.6

84.8

0.9

Total Current Liabilities

1,500.2

1,444.7

1,377.5

1,095.6

415.6

 

 

 

 

 

 

Long Term Debt

185.0

170.0

0.0

7.0

7.0

Total Long Term Debt

185.0

170.0

0.0

7.0

7.0

Total Debt

1,285.9

1,173.1

980.0

780.9

240.8

Deferred Income Tax

8.9

9.0

9.0

38.6

--

Minority Interest

175.1

111.8

100.4

100.5

9.9

Other Liabilities, Total

1,200.2

1,220.8

0.0

--

--

Total Liabilities

3,069.4

2,956.3

1,486.9

1,241.7

432.5

 

 

 

 

 

 

Common Stock, Total

0.2

0.2

0.2

0.2

0.2

Additional Paid-In Capital

1,628.5

1,616.1

1,601.9

1,585.1

1,579.5

Retained Earnings (Accumulated Deficit)

443.2

365.1

260.5

190.1

130.5

Total Equity

2,071.9

1,981.4

1,862.6

1,775.4

1,710.2

 

 

 

 

 

 

Total Liabilities & Shareholders' Equity

5,141.3

4,937.7

3,349.5

3,017.1

2,142.7

 

 

 

 

 

 

Total Common Shares Outstanding

241.95

241.95

241.95

240.02

240.02

 

 

 

 

 

 

 

 

 



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