CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded the Long-Term Issuer Default Rating (IDR) of Canadian Solar, Inc. (Canadian Solar) to 'BB-' from 'BB'. The Rating Outlook is revised to Negative from Stable. A complete list of rating actions follows at the end of this release.
The downgrade reflects the company's higher risk profile following a change in its business strategy to focus on the more volatile solar module manufacturing and 'build-to-sell' construction businesses and to exit the more stable long-term contracted solar-powered electricity generation segment.
The Negative Outlook reflects the execution risk surrounding the monetization of Canadian Solar's large portfolio of solar projects, which is necessary to reduce consolidated financial leverage. In resolving the Negative Outlook, Fitch will focus on the financial policy and consolidated leverage under the revised business model. Fitch would stabilize the ratings at 'BB-' if consolidated adjusted debt to EBITDAR and/or adjusted FFO-net leverage decline to 4.0x and 3.0x, respectively, on a sustainable basis.
KEY RATING DRIVERS
Revised Business Strategy: Fitch views the revised business strategy to focus on solar module manufacturing and 'build-to-sell' construction as elevating the business risk profile given the inherent cyclicality of these markets. Canadian Solar's downstream expansion into long-term contracted solar power systems ownership had the potential, in Fitch's view, to alleviate some that cyclicality.
Leveraged Capital Structure: Adjusted consolidated debt to EBITDAR increased close to 8x at June 30, 2016, from 5x at year-end 2015, as Canadian Solar invested in solar power systems during first-half 2016. While significantly higher than expected, Fitch expects consolidated adjusted FFO net leverage to improve with the monetization of solar projects and return to 3.0x or less. Going forward, Fitch will focus on consolidated adjusted leverage, rather than adjusted recourse leverage, as non-recourse project level debt should become a small proportion of the capital structure under the revised business model.
Monetization of Solar Projects: There is significant execution risk associated with plans to divest its large portfolio of solar projects, notwithstanding investor demand globally for solar projects. Fitch assumes that the majority of proceeds will be used to reduce outstanding debt with the remainder recycled to fund future construction projects.
Competitive Cost Position: Fitch expects Canadian Solar to maintain its cost leadership, which is vital in a declining pricing environment. Canadian Solar forecasts a 30% manufacturing cost reduction to $0.29 per watt (for Chinese mainland production) by fourth-quarter 2017, compared with $0.41 per watt during first-quarter 2016, supported by the scale of its manufacturing operations, upstream integration and a secular decline in raw material costs. Nonetheless, solar PV technology continues to evolve and the barriers to entry are limited, opening the possibility of new technologies that could reduce or eliminate Canadian Solar's competitive cost advantage.
Cyclical Market: The solar photovoltaic (PV) market has witnessed sharp peaks and troughs in recent years, a function of swings in global demand and overcapacity buildout in the supply chain. Canadian Solar's module segment gross profit margin swung from 15% to 7% during the last industry cycle. Industry-wide capacity expansions are starting to weight on pricing dynamics and point to another cycle of global profitability contraction.
Geographical Diversity: Multiple manufacturing locations and exposure to diverse end-user markets reduce Canadian Solar' business risk. Fitch believes that expansion of government policy support in China, India, and other emerging markets will further strengthen Canadian Solar's pipeline of solar projects. This could also offset any slowdown in the solar PV markets in developed markets where government subsidies are projected to decline. While proving a headwind for 2016, the extension of the investment tax credit for solar energy projects in the U.S. should support robust demand in 2017-2018.
Fragmented Financing Facilities: Canadian Solar's financing is fragmented and predominantly short-term. This strategy minimizes interest costs and reduces currency fluctuation risks, but also reduces visibility into financing flexibility and increases re-financing risks. Fitch draws significant comfort from Canadian's Solar large unrestricted cash position to meet temporary capital market dislocations and/or other unexpected cash needs.
Fitch's key assumptions within the rating case for Canadian Solar include:
--Assumed ASP range of $0.38/watt - $0.55/watt and COGS range of $0.35/watt - $0.40/watt between 2016 and 2018;
--Total module shipment of 5 GW recognized in revenue in 2016, followed by 5% growth in 2017 and 10% in 2018;
--Majority of solar power plants divested in 2017;
--About 1GW of solar projects delivered in 2018;
--No dividend and/or share buybacks in 2016-2018.
Positive Rating Action: The Rating Outlook may be revised to Stable if Canadian Solar is able to monetize a significant portion of its portfolio of solar projects resulting in consolidated adjusted debt to EBITDAR and/or adjusted FFO-net leverage declining to 4.0x and 3.0x, respectively, on a sustainable basis. A positive rating action is unlikely given the inherently cyclical nature of the PV module manufacturing and the 'build-to-sell' construction businesses.
Negative Rating Action: Future developments that may, individually or collectively, lead to a negative rating action include negative government policy or investor appetite developments adversely affecting valuation of existing solar projects; pressure on margins driven by an increase in polysilicon prices and/or oversupply of PV solar modules; aggressive acquisition or financing strategy; as well as consolidated adjusted debt to EBITDAR and/or adjusted FFO-net leverage remaining above 4.0x and 3.0x, respectively, on a sustained basis.
Fitch believes the liquidity is sufficient to meet funding needs over the next 12-18 months, supported by large unrestricted cash position.
Canadian Solar primarily finances its activities using short-term bank borrowings. While this is customary for entities operating in China, the short-term nature of the financing structure poses meaningful refinancing risk, in Fitch's view.
Fitch excludes from its debt calculation the short-term notes payable, as they are more akin to accounts payable but ascribes 100% debt-value to the convertible notes maturing in February 2019 ($128 million outstanding at second-quarter end 2016). Fitch also uses an eight times multiple of last fiscal year operating leases to estimate lease-equivalent debt.
FULL LIST OF RATING ACTIONS
Fitch has downgraded the following ratings:
Canadian Solar, Inc
--Long-Term IDR to 'BB-'from 'BB';
--Senior unsecured debt to 'BB-/RR4' from 'BB/RR4'.
The Rating Outlook is revised to Negative from Stable.
Date of Relevant Rating Committee: Sept. 21, 2016
Disclosure: There was no financial statement adjustments made that were material to the rating rationale outlined above.
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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