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Currency Hedges Aren't Enough to Protect Yingli Green Energy's Profit Margins

China-based Yingli Green Energy (YGE) is looking beyond foreign currency hedges to mitigate financial damage from the depreciating euro. With the Eurozone currency sitting at multi-year lows against the U.S. dollar and Chinese yuan, even best efforts to make more efficient use of existing assets won't be enough to protect margins and the company's core competence as a low-cost producer of solar modules.

The euro began dropping again on word from Lajos Kosa the Hungarian vice chairman of the newly elected Fidesz party, that Hungry stood little chance of avoiding a Greek-style debt crisis. In late trading on Monday, the 16-nation currency stood at US $1.195, the lowest level since April 2006. The exchange rate of the euro against the Chinese yuan was 8.176, a new low since PRC exchange rate reforms in 2005.

Yingli is headquartered in Baoding, China (about 87 miles south of Beijing) to leverage low-cost advantages of government-subsidized electric power (manufacturing facilities) and cheap indigenous labor markets. Nonetheless, like other local manufacturers, the company's gross margin is vulnerable to a depreciating euro, as it derives most of its sales in Europe, primarily from Germany and Spain: with manufacturing principally sourced in China, a rising yuan against a falling Euro raises the cost of goods produced. Unlike some competitors, such as Canadian Solar (CSIQ), management at Yingli should be commended for not being caught flat-footed by the plunging Eurozone currency. In addition to typical currency hedging programs, management smartly contracted almost 45 percent of its photovoltaic (PV) module shipments in U.S. dollars, helping to mitigate the 6.5 percent depreciation in euro value against the yuan (on average selling prices and operating performance).

Notwithstanding relentless assaults on average selling prices (ASPs) from European member nation cuts (real and anticipated) on solar subsidies and the depreciating euro against a basket of commonly traded currencies, Yingli posted a sequential 370 basis points pop in gross margin to 33.3 percent in its first quarter. Chief financial officer Bryan Li attributed the performance gain to another 15 percent decline in the blended cost of polysilicon, improved cell conversion rates, reduced consumption of polysilicon per watt, and decreased non-poly processing cost (to $0.75 per watt in first quarter, down from $0.80 for full year 2009).

In the here and now Europe retains the go-to solar market. Yingli's Li spent a fair amount of time on the quarterly earnings call detailing company efforts to offset the impact of the euro devaluation on margins in coming quarters. Strategic moves, which could serve as a template for other businesses caught in this Eurozone vortex, include the following action steps:

  • Increasing foreign currency hedging activities and looking at ways to encourage EU-based customers to get more contracted monies moved over to US dollars (albeit this inducement could likely clip ASPs);
  • Accelerating collection of accounts receivables and limit forward credit risks;
  • Lowering conversion costs by increasing multi-crystalline cell conversion efficiency (from 16.5 percent in first quarter to a targeted 18.5 percent); and,
  • Tapping upstream subsidiaries along its integrated supply chain to lower their costs, too, such as its "baking" operations -- more slices of "bread" (thinner wafer sizes) from bigger "loaves" (larger cylindrical, crystal ingots) cooked with less expensive "ingredients" (of purified silicon). Poly-consumption per watt has decreased from 6.8 gram per watt in 2008 to 5.9 grams per watt in the first quarter of 2010.
Yingli's balance sheet and cash flow are also negatively impacted by the depreciating euro. For example more than 50 percent of its account receivables are euro-denominated.

Steps being taken to limit loss exposure upon revaluation to yuan at quarter's end include, but are not limited to: more careful monitoring of credit risk and financing, accelerated collections due from customers, and increased bundling and sales of trade receivables.

Day sales outstanding (a measure of how long it takes to collect payment from customers) decreased to 45 days in first quarter from 64 days in fourth-quarter 2009, said CFO Li, primarily a result of proactive collection steps.

It shouldn't be lost on readers, however, that a depreciating euro also benefits the liability side of Yingli's balance sheet: raw material and equipment purchases bought on credit by Yingli on December 31 for € 250 million would be listed as liabilities of 2.44 billion yuan. At June 7, 2010, the same debt could be paid off with only 2.04 billion yuan.

Payable days outstanding increased to 111 days in first-quarter 2010 compared to 94 days in Q4 2009, Li noted on the earnings call. A case where a payment delayed benefits cash flow.

On Yingli's first-quarter earnings call, CFO Li reaffirmed management's forecasted a gross margin target of 27 percent to 29 percent for full-year 2010. With the depreciating euro showing no signs of a bottom against either the U.S. dollar or Chinese yuan, this guidance will likely be contracted in coming months.

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