TraderMark - Steller Trina Solar (TSL) Earnings Masked by Currency Adjustment

In this era where the masses only look at what Briefing.com tells them and/or never actually open up an earnings report to look inside but only react to the "headline" number, Trina Solar (TSL) is giving back yesterday's gains on what I consider to be a stellar report. The stock is back down to the $46 level, so I'll be adding to my position when the market opens as I consider this a gift based on what I saw today. I'll explain the reality behind the numbers below.

As anyone in the market for more than a few months know, earnings are all about "expectations" - Trina Solar reported $0.51 EPS which beat the analysts expectations of $0.48. Considering the small P/E ratio this normally would be good enough but considering its "solar" and people want to game earnings, people were hoping for a larger beat - my estimate was they would actually do something in the $0.60 to $0.65 range. Which they did achieve. Huh? You just said they did $0.51.... how did they reach the $0.60-$0.65 range?

Well essentially the management of Trina Solar, as they are apt to do, pulled a surprise on us (in the past they decided to surprise us with adventures such as starting a new polysilicon plant out of the blue, without any heads up), but this time around they decided to change their currency from Chinese Renminbi to US Dollars. Strange. I have no idea why and there was no heads up for this. Here is their explanation:

• Effective January 1, 2008, the Company changed the functional currency of its operating subsidiary, Changzhou Trina Solar Energy Co., Ltd. (''Trina China''), from RMB to US dollars. This change is in accordance with FASB Statement No. 52, "Foreign Currency Translation", and was based on Trina China's significant and sustained shift in conducting a majority of its business activities in US dollars. During the first quarter of 2008, the Company recorded an exchange loss of $4.0 million, which was primarily associated with Trina China's non-US-denominated obligations that are now required to be remeasured in the US dollar functional currency. Such remeasurements are and will continue to be, to the extent we continue to have such non-US denominated obligations, recorded as transaction gains or losses in the consolidated statement of operations.

So the net effect of said "decision" was a $4.0M loss this quarter due to this currency change. This is obviously not part of their operational business but more of an accounting function that won't be repeating in future quarters. So if we took away this "decision" their net income would of been $16.9M. With this adjustment their net income was $12.9M - essentially they lost 24% of their profit this quarter due to this exchange. But again, this has nothing to do with their core business.

So what would their EPS of been if they had $0 gain/loss from foreign currency? $16.9M / 25.1M shares = $0.67 EPS

And we would of woken up today to a stock probably trading in the upper $50s as Trina Solar beat earnings expectations of $0.48 by 19 cents. But so it goes, and again - the "masses" will just react to the headline number, which incredibly even with losing $4M in profit due to the currency change STILL beat expectations. That's how strong business is.

Just for reference the 3 main competitors who are most like Trina are Suntech Power (STP), Yingli Green Energy (YGE), and Solarfun Power (SOLF). In the last quarter how did they benefit/gain from foreign currency exchange?

1. Suntech Power gained $2.9M due to foreign currency exchange (they earned 33 cents per share, which means 2 of the 33 cents had nothing to do with their business, only foreign currency exchange)
   
2. Yingli Green Energy gained $9.8M due to foreign currency exchange (they earned 25 cents per share, which means 7 of the 25 cents had nothing to do with their business, only foreign currency exchange)
3. Solarfun Power gained $2.8M due to foreign currency exchange (they earned 31.5 cents per share, which means 5.5 of the 31.5 cents had nothing to do with their business, only foreign currency exchange)

So here is the irony in it all - all 3 of their most similar competitors created "earnings" (anywhere from 2 to 7 cents) from the foreign currency exchange... not only did Trina Solar not get that "cheat" to help goose their earnings, they gave away 16 cents worth of earnings due to this decision. It is almost bemusing in a way.

But again, NONE of these companies should benefit (or lose) from the currency exchange in reality - but just like most US multinationals are "beating estimates" by having a weak dollar and hence they get these currency benefits (which would reverse if the dollar ever rallied for more than a few days), these companies have been able to goose their earnings the same way. Most investors again, do not look past the headline number or dig in and see this - they just go off what Reuters or Briefing.com tells them.

So in summary what I am saying is if Trina Solar had not seen any benefits like their 3 main peers and simply gained NOTHING from currency exchange they would of reported 67 cents and beat the estimate by 19 cents. If they had gained 2-7 cents more from foreign currency exchange (like their closest peers) they would of reported anywhere from 69 cents to 74 cents. My goal was 60 to 65 cents (analysts 48). So while the masses believe this was a small beat, the reality is this was a tremendous beat. So we'll buy more on the panic selling this AM.

Back to Trina Solar earnings - gross margins continue to be best in class, repeating the trick from last quarter [Mar 4: Long Suffering Trina Solar Finally Gets Some Relief] coming in at 25.8%, above my expectations and above Trina's own guidance.

And here is guidance which is also upped from last quarter

• For the second quarter of 2008, the Company expects to ship between 43 MW and 45 MW of PV modules and has expectations of total net revenues in the range of $169 million to $177 million. The Company believes gross margin for the second quarter will likely be between 23% and 25% and estimates operating margin to range between 13.5% to 15.5% of total net revenues.

• For the full year of 2008 the Company expects total net revenues to be in the range of $770 million to $808 million, with PV module shipments between 200 MW to 210 MW. The Company is expecting gross margin for the year between 23% and 25% and believes operating margin will likely be in the range of 15% to 17% of total net revenues.

For future margin guidance keep in mind they said 23-25% for this quarter and came in at 25.8%. So they are playing the Wall Street game - under promise, over deliver (Apple is a master of this). All in all, a great report - which the lemmings on the street in their short sightedness will miss. Due to this currency exchange situation I am unclear if my $4.00 target for EPS for 2008 will still be hit since I was incorporating 60 cents this quarter as part of my model but it should be (minimum) $3.80s-$3.90s for the year. But they did up revenue guidance for the year so $4+ should still be do-able.

That said, I am getting tired of management constantly pulling these surprised out of their back pocket, which is leading to an industry leading LOW P/E ratio since you never know what they are going to pull next. Thankfully their operations are so strong it is counteracting the management "surprises".

I'll be adding on the weak open this AM.

EDIT 9:45 AM - I've moved Trina Solar from a 7% weight to 11% weight. This is a $70 stock masquerading as a $46 dollar stock.

Source: http://www.fundmymutualfund.com/2008/06/steller-trina-solar-tsl-earnings-masked.html