Sector leader SolarWorld faces mounting margin risk
FRANKFURT (Reuters) - SolarWorld, Germany's top solar company, will see its margins drop this year as its premium price strategy comes under attack, hurting one of the last intact investment cases in the sector.
Despite looming cuts in solar incentives in Germany -- the world's biggest market for the sector's products -- and an industry crisis caused by overcapacity and a price slump, SolarWorld is still one of the few profitable players with a good strategic position.
It is the only company out of Germany's four big solar cell and module makers to have turned a profit last year, mainly due to the fact that it also manufactures other components and is thus able to offset pricing pressure to some extent.
So far, the company has relied on its strong brand name, which usually lets it charge a premium of up to 30 percent on its panels compared with Chinese peers.
But if it wants to remain competitive it needs to lower product prices, which will further hit margins unless production costs are reduced, analysts said.
"In the absence of a strategy shift away from its high-cost manufacturing model, we struggle to see a margin stabilization any time soon," UBS analyst Patrick Hummel wrote.
Imminent solar incentive cuts in the German market, where SolarWorld generates almost 70 percent of sales, are forcing domestic players to quickly enter markets abroad to offset a potential slump in demand.
SolarWorld may be able to keep its price premium in Germany -- where football star Lukas Podolski supports a massive ad campaign -- but exporting it will be difficult.
"If the strategy (of premiums) has been working in 2009, when pricing pressure from Chinese peers was quite severe already, why wouldn't it work it 2010?" asked Ben Lynch at Bryan, Garnier & Co, who is rated as the top SolarWorld analyst by Thomson Reuters database StarMine.
"But Germany will be a smaller market for SolarWorld this year and it cannot duplicate the premium strategy to other countries, so on average, its premium will fall."
Peter Wirtz, analyst at WestLB, expects the share of German sales to SolarWorld's turnover to fall to 60 percent in 2010.
SHAKY EBIT MARGIN
While Thomson Reuters I/B/E/S estimates suggest a 2010 EBIT margin of 11.5 percent, StarMine forecasts are for a 10.3 percent margin. This compared with a 2009 margin of 15 percent, second only to the 24.1 percent achieved by German peer SMA Solar, the world's largest maker of solar inverters.
SolarWorld's fourth-quarter results already showed low profitability with a 9-percent EBIT margin, although the October to December period was the year's strongest in terms of sales.
"While SolarWorld remains one of the relatively best positioned players in the industry, the global photovoltaic market environment ... remains tough," analysts at HSBC wrote, adding they see further price and margin pressure as well as downside potential to EBIT forecasts.
The Thomson Reuters I/B/E/S forecast for 2010 EBIT, now at 139.32 million euros ($191.5 million), looks too optimistic compared with the 123.9 million estimate in StarMine, which weights analyst forecasts according to their track records.
The 11.1 percent discount of the StarMine estimate -- also called "predicted surprise" -- suggests the direction of future earnings revisions and surprises.
StarMine research has shown that when the "SmartEstimate" diverges from the I/B/E/S consensus by 2 percent or more, the signal successfully predicts the direction of the actual surprise with a success rate of about 70 percent across regions, market caps, sectors and financial measures.
Margin pressure will also be exacerbated by SolarWorld's inability to cut production costs, analysts say.
Royal Bank of Scotland analysts, who do not expect it to be able to cut costs sufficiently, added: "We expect the company's retail premium to fall to 15 percent by year-end 2010."
(Editing by Sitaraman Shankar)