Sit Out This Price War—and Profit

11/26/2010 10:00 am EST


Jim Jubak

Founder and Editor,

Jim is taking a holiday. Here is a review of his recent buy of Yingli Green Energy Holding Co. to tide you over until Monday.

While the United States has dithered over how, when, and whether to invest in the energy industries of the future, solar cells and panels have become a commodity business. And that gives a huge edge to China’s solar manufacturers with their significantly lower labor costs.

Morningstar estimates that it costs 20% to 30% less to produce a solar panel using traditional solar panel technology in China than in Europe. (Notice, please, the word “traditional.” Thin-film solar technologies are an entirely different ballgame.) That has led to a global price war at a time of an uncertain demand for solar panels as companies try to grab or maintain market share. For investors, price wars always present the danger that competitors will cut their prices so far that they sacrifice profit margins in an effort to grow market share. That’s not a formula that investors want to buy into.

So the best news from China’s Yingli Green Energy Holding Co.’s (NYSE: YGE) third-quarter earnings report November 19 was that gross margin stayed extraordinarily healthy at 33.3%. Gross margin beat the company’s guidance for 31% to 32% for the quarter. Gross margin in the second quarter of 2010 was 33.5%, and in the third quarter of 2009, the figure was 22.5%. Operating margin came in at 22.4%.

Guidance for the first half of 2011 was not as downbeat as that from other solar panel producers—that’s either a reflection of Yingli’s strong market position or a bit of wishful thinking. (My suspicion is some of both.) The company forecast that average selling prices would be flat in the first half of 2011 and show a slight decline in quarters three and four. It would surprise me if prices were that strong in 2011. Germany, the world’s largest market for solar panels because of generous government support, has said it will cut subsidies by 13%. Spain and the United States, other big solar markets, are under extreme budget pressure. All this as the global solar industry, including Chinese solar producers, is expanding capacity.

This is where a second Yingli advantage comes into play. Besides lower labor costs, Chinese solar manufacturers have access to extremely cheap financing. That enables a company like Yingli to invest in a new silicon plant, set to go into production at the end of 2010, even though the returns on that investment are likely to be relatively low. But although that plant isn’t likely to be cost-competitive with the best silicon producers in the world, Yingli will, by cutting out the middleman’s profit for the key raw material in making traditional solar panels, be able to raise its own gross margins.

Higher gross margins would give Yingli a choice between grabbing market share while maintaining current margins and increasing its profits. With China in the midst of a solar energy drive that is on track to make China the world’s largest solar market by 2014, that’s not a bad choice to have. (And since Chinese officials are very good at devising methods to give Chinese companies preferential access to China’s markets without violating global trading rules, I expect that the bulk of that growth will go to Chinese solar manufacturers. That could be why Yingli is so confident about demand and average selling prices in 2011.)

I was going to wait a few days to see if I could get these shares for less than $11, but lo and behold, the stock dropped to $10.76 on Monday.

So as of November 22, I’m adding shares of Yingli Green Energy Holdings to Jubak’s Picks with a target price of $16 a share by October 2011.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund’s portfolio here.

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