3 Red Flags From Canadian Solar's Earnings Report

Shares of Canadian Solar Inc. (NASDAQ: CSIQ) plunged double digits on Thursday after the company reported third-quarter earnings. The quarter should have been strong, as high demand and rising solar panel prices give the industry tailwinds.

But Canadian Solar reported only $13.3 million of net income on $912.2 million in revenue. There are some major challenges that Canadian Solar and other Chinese solar manufacturers will have to contend with heading into 2018.

2018 demand could be weak

2017 has proven to be an extremely good year for solar manufacturers, but the positive trend may be short-lived.

U.S. demand has been strong because developers are either finishing projects early or stockpiling panels ahead of the Section 201 trade case decision that could add significant tariffs on solar imports.

In China, high feed-in tariffs and the Top Runner program, which promotes projects built with high-efficiency solar panels, could be slashed in 2018. China may install as much as 50 gigawatts of solar in 2017, so a pullback from that level wouldn't be surprising.

Over the short term, the demand has led to high volume and strong pricing, but in the earnings release, CEO Shawn Qu warned that a "pull-in effect appears to have driven the spot market solar module price higher globally and pushed low-price solar module demand into 2018."

If Canadian Solar is only able to make $13.3 million in net income in ideal operating conditions, it may be in for a bad year if demand weakens in 2018.

Costs are rising

High demand in 2017 has led to high prices for Canadian Solar's raw materials. Management said that prices of polysilicon, which goes into all silicon-based solar panels, have gone up, and so has the price of aluminum. 

Components like aluminum and glass play a significant role in the cost of a solar panel, so when commodity prices go up, they impact all solar manufacturers.

Foreign currency is now a headwind

Not only are costs rising, but currency isn't helping with margins outside of China. Management said that "the unexpected raw material cost increase and the appreciation of Chinese currency over the past few months will make it challenging for us to reach our previously-set solar module manufacturing cost target by the end of 2017."

Manufacturing in China has long been an advantage for manufacturers like Canadian Solar, but right now it's working against the company and the rest of the industry. And it could have a bigger negative effect on gross margins than natural industry pressures.

Overall, a much better year than expected for solar panel demand, though prices may not lead to the level of profitability that investors projected. And that's not good news for highly leveraged Chinese solar manufacturers like Canadian Solar.

10 stocks we like better than Canadian SolarWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Canadian Solar wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of November 6, 2017

Travis Hoium has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.