Where is the progress of the photovoltaic rebound?

The photovoltaic industry has always been an essential technology sector in a bull market. After a prolonged period of price decline due to a cyclical bottom and performance collapse, valuations have returned to low levels. Currently, in a bull market, it is a flexible sector with ample upward potential.

However, it is not feasible to adopt an increasingly speculative attitude towards investing in the photovoltaic sector. At present, the performance of the photovoltaic sector remains dismal.

If a company increases its losses while the stock price rises, what awaits is continuous issuance of new shares and reductions in holdings. Investors should focus on what changes are occurring in the fundamentals of the photovoltaic industry and whether there is sufficient margin of safety. Is the photovoltaic sector currently at the starting point of a dual recovery in valuation and profitability?

1. Profitability is indeed improving

After several months of speculation about the photovoltaic sector hitting bottom, photovoltaic stocks have updated their financial reports for two quarters. From the data, the results are not ideal, at least there are no signs of a cyclical turnaround.

In the latest quarter, photovoltaic stocks did not significantly worsen their losses. Among the leading companies with the largest losses, Tongwei and LONGi have begun to narrow their losses, while JA Solar has even turned a profit. However, TCL Zhonghuan and Trina Solar have increased their losses. Overall, the industry's profits have improved, but the extent of losses has not continued to decline. It can be seen that in the mid-year report, photovoltaic equipment companies accumulated losses of 5 billion, with losses of 8.1 billion in the third quarter, and a single quarter loss of 3.1 billion, showing no significant expansion.

However, it is noteworthy that the total operating cash flow of all photovoltaic equipment companies in the 2024 mid-year report was -26.7 billion, which decreased to -9.4 billion in Q3, reflecting that the industry has begun to show positive cash flow. The EBITDA in Q3 has actually improved on a quarter-on-quarter basis, and many companies' Q3 performance also included a significant amount of impairment, indicating that Q3 indeed shows signs of bottoming out. This is the hypothesis of the quarterly loss bottom for photovoltaics, which is becoming increasingly plausible.

In recent months, relevant authorities have begun to change the photovoltaic industry from top to bottom, including continuous industry rectifications, policies encouraging mergers and acquisitions, and even stipulating that the bidding price for photovoltaic components must not be lower than 0.68. Interestingly, the CEOs of leading companies in the photovoltaic industry, such as Zhonghuan, LONGi, Trina, and Tongwei, discussed on CCTV, claiming to promote orderly competition and win-win cooperation.

All these actions seem to be accelerating the industry's search for a bottom. This also makes the Q3 performance appear more likely to be a turning point.

The key point is that industry output has indeed begun to decline, promoting a balance between supply and demand, and the price decline of various core components is also slowing down. In fact, starting from the entire third quarter, both the output curve and the price decline curve have also begun to flatten. Moreover, it should be noted that this phenomenon was already evident before the minimum bidding price restriction of 0.68

From this perspective, everyone's hope is to lock in the lowest price for components, while everyone plays along to clear excess capacity until supply and demand are balanced, depleting inventory. As global photovoltaic installation demand begins to stabilize and grow, the growth path for the industry will naturally be established.

II. Anticipating Difficulties and Cyclical Disruptions in Advance

It is noted that the company currently suffering the largest losses in the industry is the leading company LONGi Green Energy, with losses reaching 6.5 billion. The total annual loss may be even higher, marking a record for photovoltaic stocks in recent years. Compared to the downturn in the photovoltaic cycle in 2018, this is much more severe, as there were no large-scale performance losses in 2018, and the absolute loss amount was not high.

This year's industry losses are related to the severe cyclical downturn following the 2008 financial crisis and the sanctions on photovoltaics overseas in 2021, which led to a sharp price drop. Previous photovoltaic giants like Suntech and Yingli were eliminated during that cycle.

The fundamental reason for this cyclical bottoming is, of course, oversupply. After 2020, global new energy development flourished, the photovoltaic market accelerated its recovery, investment in green energy peaked, and photovoltaic installation capacity continued to surge. Coupled with local governments' efforts to attract investment and the temptation of low-price subsidies to build capacity, China's photovoltaic capacity became uncontrollable.

When supply and demand are balanced, the cycle will naturally reverse, which simply involves reducing supply while waiting for global photovoltaic installation demand to grow naturally. From the demand perspective, the situation is not too concerning; in the first half of the year, China's photovoltaic installations grew by 30%. Although this is a slowdown compared to last year's 60% growth rate, it is still quite fast, and globally, the growth level remains high. This year, global new photovoltaic installations are expected to reach 592 GW.

However, in reality, the pace of expansion is still too strong, with domestic companies' total capacity exceeding 1000 GW. Most photovoltaic companies have experienced cycles and are aware that oversupply will ultimately lead to everyone's downfall. So why can't they resist expanding during this time?

One easily overlooked point is that during the cyclical downturn in 2018, the industry did not experience significant losses. Everyone assumed that there were still profits at the bottom of the photovoltaic industry; the cycle was merely a matter of earning less or more. This industry is not like pig farming or mining; the products have technological barriers and content, unlike the past where there were huge profits and losses, and excess capacity could just be left idle.

It is this mindset that has reduced the conservatism learned over the past decade or so in the industry. For example, Tongwei, which relied on counter-cyclical rapid growth in the past, still increased investments despite seeing industry overcapacity, attempting to replicate its success. This is the key reason for the persistent excess capacity However, from the industry perspective above, it can be seen that the operating rate of first-tier companies has already dropped to 50%. Calculating this figure, if everyone is at a 50% operating rate, supply and global demand have already reached a balance, which explains the trend of prices not falling.

The logic of the first part of the recovery seems perfect, but one point remains unclear: is the decline in operating rates permanent or temporary?

Most companies are currently opting to halt production and operations, but they have not completely shut down production lines. Behind the tacit agreements and minimum price restrictions, there has not been a complete handling of production capacity. The operating rate can be low, but it can also be increased at any time. Once photovoltaic demand rises, these flexible production lines will be revived, suppressing demand again, and thus, the minimum price will turn into the highest price limit.

Does this concept sound familiar?

It is similar to housing prices; the guide price was originally used as a minimum reference price but later became the ceiling for transaction prices. Essentially, it is the visible hand attempting to change the cycle, but it inadvertently alters the speed of the cycle's evolution—not accelerating it, but delaying it.

Currently, the structure of participants in the entire photovoltaic industry has become concentrated. It can be seen that the shipping plans of leading companies combined are basically equivalent to global demand.

In the past, the industry concentration was dispersed, and eliminating small companies could achieve industry concentration. Now, even if all photovoltaic equipment companies outside the top ten are removed, it would be of no use. Moreover, most of the companies behind are midstream and upstream component manufacturers. Under the trend of integration, the space originally available to them is also limited, so this kind of large eating small does not help optimize industry capacity.

According to past logical deductions, the sign of industry cycle clearing is the exit of 1-2 giants.

Well then, everyone is cooperating, so who will help concentrate the industry? The most optimistic approach would be for each company to adhere to a unified principle, permanently reducing capacity by 50%, while maintaining their market share. However, no company can even achieve a permanent reduction in capacity, and this 50% reduction is not realistic at all. Moreover, if reduced proportionally, it would be unfair to those companies that do not have enough capacity expansion. If not reduced by a fixed proportion, how much should each company reduce? This is almost an unsolvable dispute.

Therefore, in this situation, attempting to limit prices, waiting for demand to rise, and gradually recovering is akin to the real estate strategy of trading time for space; short-term pain becomes long-term pain. In this scenario, the seemingly perfect recovery logic will actually face significant operational difficulties. One company announced a complete shutdown of its factory and stated that it would strictly implement capacity reductions by a specific proportion, but currently, no company has truly done this Moreover, with the arrival of such expectations and the ongoing bull market during this period, the trend of speculating on low-priced distressed stocks has led to a significant rise in the photovoltaic sector, despite its pessimistic fundamentals, which has reduced the investment cost-effectiveness of the industry.

In the third quarter, the pig cycle has fully completed its cyclical rebound in profit explosion, but compared to every previous pig cycle, it has been quite quiet, with no explosive stock price increases or lively investments. The core issue is that funds had already positioned themselves in pork stocks two years before the profit rebound, and the PB valuation is at historical highs compared to ten years ago or compared to other cyclical stocks (coal, oil, shipping), which is why stock prices have remained stagnant.

Currently, the PB valuation of the entire photovoltaic equipment industry is not considered outrageous compared to the industry's peak. However, if assessed using the cyclical stock investment paradigm of 1x PB, it becomes quite unreasonable. The high PB in the industry is primarily due to the overall high returns and good business models. However, at least from this round of corporate production to the reduction of positions, with over a hundred billion in profits wasted and capacity being destroyed again, leading to losses close to a hundred billion as seen in the past, it is clear that the cyclical nature of the industry has not changed. Resource stocks have transitioned from below 1x PB to a sustained bull market for several years. In other words, excessively high PB has also blocked the opportunity for a long bull market. Unless profit explosions begin in the next quarter to quickly repair the balance sheets, this is almost unrealistic