How Risky Is Canadian Solar Inc.?

By Travis Hoium Markets Fool.com

The solar industry is full of both high potential and high risk. As the cost of solar energy falls, the market potential grows, but this goes hand in hand with more and more companies running into financial trouble.

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Canadian Solar Inc. (NASDAQ: CSIQ) has built itself into one of the largest solar manufacturers in the world, with 5.8 GW of module capacity. That's a lot of solar modules, and it could allow the company to capture the largest market share of any manufacturer in the world. But it could also lead to high fixed costs that have brought down many companies before. With that in mind, here are the two risk factors investors should watch in 2017.

Image source: Getty Images.

Can anyone make money manufacturing solar panels?

One of the most notable events to happen in 2016 for solar was a rapid plunge in the price of solar modules in the third quarter. In a single quarter, prices fell 25% and hit a low of less than $0.40 per watt on the spot market.

Canadian Solar didn't see revenue or profits plunge as a result of the decline in prices immediately because it doesn't sell all of its panels on the spot market, but the price reduction is on the horizon. Management recently said that its cost per watt for solar modules was $0.35, meaning that in a best-case scenario, the company will become barely operationally profitable in the near future.. Needless to say, this margin decline could hit hard in 2017 and there's no telling when the situation will abate.

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The upside is that low panel prices are hitting everyone in the solar industry and Canadian solar has built a low-cost manufacturing model. And as a top-tier supplier, it shouldn't be hit as hard as lower-level module companies that may have to sell panels for a loss. But falling solar panel prices aren't good for any solar manufacturer and the trend presents a risk for 2017.

The project business suddenly became very high risk

Canadian Solar was holding $1.2 billion of project assets on the balance sheet at the end of the third quarter and the value of those assets could be falling. I recently highlighted that interest rates are on the rise and a 2% rise in rates could result in an 18% decline in project value. With $1.2 billion of assets on the balance sheet, there are hundreds of millions of dollars hanging on what the projects can be sold for.

The risk is that a 2.0 GW late-stage pipeline of projects will lose value as well. Canadian Solar has spent a lot of money over the last few years building the project pipeline, but if recent trends hold, those projects may now be worth a lot less or, in a worst-case scenario, be underwater.

What to watch in 2017

Investors will want to watch how Canadian Solar's gross margins trend in 2017. The company needs to keep costs low and plants running at full capacity to squeeze out a profit, which could be a challenge.

The price solar projects are sold for will also be important. Values have come down in the last six months, and if the trend continues, it would be a negative for the company overall.

On the positive side, falling solar panel costs are helping drive lower solar energy costs around the world, which grows the market generally. So, the future isn't dim for those who can get past the challenges that lie ahead.

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Travis Hoium has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.