Closing Yingli Green Energy (YGE) position this morning

My crack staff of 1 (myself) finally had time to listen to the Yingli (YGE) conference call last night; unfortunately Seeking Alpha did not have a conference call transcript so I actually had to spend an hour listening to the darn thing.

First, this was Yingli's first public quarter. I came impressed with the depth and breadth of their first earnings report, especially as a Chinese company. Some others I have read through from foreign companies lacked about 70% of the detail that Yingli was kind enough to provide.

Second, operationally I think Yingli appears to be doing very well all things considering (polysilicon shortage in the sector). Revenue growth is tremendous. Capacity expansion is on track. Gross margins are holding (22.7% in most recent quarter), whereas some other players are seeing dips to upper teens or worse. ASPs holding steady, whereas some other players are seeing some substantial dips.

Operationally I like the company. I like their guidance for 2nd half gross margins to hold at these levels. They have 50% of their polysilicon secured for 2008, despite massive expansion plans. I like their focus on Spain (80% of sales last quarter) which allowed them keep ASPs (Average Selling Prices) steady since Spain is not seeing the reduction in gov't subsidies that the biggest world market for solar power, Germany, has been showing.

But here are my concerns:
YGE is a recent IPO - therefore their last quarter they used a weighted average share count, instead of their full share count - which basically means if a company goes public on the 45th day of a quarter (90 days) their average weighted share count in their first public earnings report would be half of the true number. So on the earnings report just published they showed 79M outstanding shares, when the real number is closer to 127M.

Second, they have a confusing and not yet measurable (or at least clearly measurable) preferred shareholder dilution coming up, which could expand outstanding shares even further than the 127M. What exactly the number is, Yingli would not share on the call, despite being peppered by an analyst on the question. He speculated 180M. That is not a good thing.

Stocks are eventually measured on earnings per share. The more shares, the more diluted each dollar of earnings becomes. I remember when Yingli first IPO'd I was dismayed at the huge amount of shares they were bringing public - many companies of this size start with 20-40M shares. Yingli went with the nearly 130M. Hence their earnings growth (per share) would be stunted, despite huge pure earnings growth potential.

So let's look at their numbers.
Last quarter they reported $9.4M in net income.
They had two transitory expenses, which they considered accounting transactions, but essentially were a sweet deal for insiders pre IPO, which resulted in charges of $3.0M and $1.7M. Yingli stated for accounting purposes this was a 1x hit. So let's back that out and say the $9.4M is a good number for net income on $118M in revenue.

$9.4M over weighted average 79M shares = $0.12 EPS
however if it was spread over the 127M shares = $0.074 EPS

So you can see that's a nearly 40% drop in earnings. Even with continued huge revenue growth, growing earnings off a 127M share base is a lot tougher than say 22M share base that Trina Solar (TSL) has.

Yingli has guided for $460 to $480M in revenue for the year, so back half of the year I can only see about $0.20 more EPS generated, maybe $0.09 and $0.11 or so in Q3 and Q4, with expectations of revenue continuing growth (which I don't doubt), gross margins holding (always a question), and ASPs not falling (always a question).

Now that is the story when shares are 127M. What if there is more dilution that the analyst pointed to? While earnings (net income) will continue its great growth, the earnings PER share will be stuck in quicksand. To put into perspective how many shares this is, Sunech Power (STP), the largest Chinese PV maker has about 170M shares outstanding, and its 2-2.5x as large of a company as Yingli.

So this is my main issue, and reason to close this position. One smaller thing which bothers me is the reduction in R&D spending. Yingli spent a whopping $417K on R&D - as a percent of revenue that's negligible. Compare to Suntech's $4.2M. Trina Solar spent as much as Yingli and it's a substantially smaller company. R&D is important to reduce silicon usage, and keeping ahead of the curve in a market that will increasingly become commoditized over time.

If the R&D issue were the only issue, I could look it over, but the share count issue, especially with the unknown dilution possible in the future is the main issue here. It is too bad, because operationally I really like what Yingli has been able to do.

With the expulsion of Yingli Green Energy, I will be looking for a new candidate to fill out my basket of solar stocks - LDK Solar (LDK) looks like a candidate. I have traded this stock from the $20s in my personal account and the stock is now in the $40s and its chart has remained very strong despite the ups and downs of the market. LDK is a more narrow focus, selling wafers but it's an important part of the supply chain.

SA/SS

Long STP, TSL in fund; long STP, TSL in personal account