Failure of Canadian Solar - Essay Example

?EXECUTIVE summary The report analyses a situation where North Mountain Engagements LLP evaluates one of the firms in the international solar PV industry for investment purposes. Canadian Solar is not being able to achieve profitability and this is the reason why the company has been suffering from losses despite of increasing revenues and increasing growth in the demand of products. There are several reasons that have been responsible for the failure of Canadian and some of the major reasons and all these reasons have been identified by North Mountain Engagements which is why it is planning to invest in Canadian Solar. North Mountain Engagements has a risky firm with higher debt to equity ratio because of which investors demand higher return and they invest in firms whose value could be doubled within two years. With several opportunities in the industry, North Mountain Engagements feels that the Canadian Solar can live up to the potential and become an important firm to invest. Recommendations have been given in the report so that Canadian Solar could improve its position in the market and improve its profitability. introduction North Mountain Engagements LLP is a Hedge fund company which invests in different companies to increase their capital however the company invests in only those companies of which it could improve the earnings significantly and increase the value of the firm by twice. This is the reason the company invests and analyses the company thoroughly before it makes any investment decision. The report analyses one of the companies in the Solar PV industry, Canadian Solar which has been suffering from losses from 2006 and this report investigates whether the company would be able to improve its earnings by changing their strategies. North Mountain Engagements has a higher debt to equity ratio which is defined as total debt of the company in comparison to total equity and higher debt to equity ratio reflects higher risk (Barro, & Sala-I-Martin, 1992). Thus, with higher risks shareholders demand higher return (Besley, & Brigham, 2007) so; this is the reason why the North Mountain Engagements LLP requires higher profits. Canadian Solar has been known over the years as CSI meaning Canadian Solar International is suffering from losses despite of the overall demand in the industry has been growing and growing revenues of the company. Canadian Solar has reported total growth of 135.7% in five years from 2004 to 2008 with revenues of the company growing from $9.7 million to $705 million. There are several reasons which have led Canadian Solar to situation where the company is showing negative net income and one of the major reasons for Canadian Solar suffering from losses is the increasing competition and this report discusses different factors that have resulted Canadian Solar to be in loss. Industry Overview The world economy has been going through recession and this recession has made an impact on major economies of the world. However, there are other factors besides recession which have influenced the profitability of Canadian Solar though the demand of solar PV industry has been showing tremendous growth since 1998 globally. In addition to this, steps and measures taken by government have been fruitful for the firms in the industry as it encouraged people to use more solar photovoltaic (PV) technology. The following graph reflects the demand of solar PV in the international market and it can be seen that the demand slope has increased considerable in the last five years or so. (Source: Mitchell, 2010) Demand has increased at a much rapid pace than previous years since 2004. The demand has been growing in the range of 21% to 27% from 1998 to 2003 however since 2004, the global demand has reported much higher growth rate in the range of 31% to 38% till 2007. Demand in 2008 reported much higher growth as it reached over 60%. The increasing demand of solar PV internationally indicates that the demand would further increase in the years to come and it is the right time for firms in the industry to capitalize the opportunity. The following graph reflects the increasing growth rate of Solar PV internationally: (Source: Mitchell, 2010) The other reason which has been regarded as responsible for changes in the demand of the industry is Spain incentive programs. Spain has been considered as the most important market in 2008 as 45.4% of the Solar PVs have been installed. The following graph represents the installation of solar PV around the world in 2008: (Source: Mitchell, 2010) objectives The objective of this report is to analyse and recommend strategies to Canadian Solar in order to improve its market position and improve its profitability by analysing the potential in the industry and potential in the company. As North Mountain Engagements invests in firms whose value can be doubled within two years therefore if Canadian Solar is able to improve its value then NME would be investing in the company. swot analysis of canadian solar Strengths Canadian Solar has been operating in different international market which is a major strength of the company. The company has re-branded itself and promoted as a Canadian company and it uses Canadian origin to market itself. Canadian is well received by people around the world and people from around the world have a connection to Canada. So, by using positive Canadian image company differentiates itself from other Chinese firms. Weaknesses The company has been suffering from losses since 2006 and it has not been able to make its net profit positive. Gross profit margin of the company is very low indicating higher cost of revenues, whereas competing firms have lower cost of revenues thus making it difficult for Canadian Solar to achieve positive net earnings. Opportunities There are lots of opportunities in the industry for Canadian Solar to grow. The growing demand of solar PV industry is an important opportunity for the company to capitalise and it has been anticipated that the demand would continue to grow in future. Deutsche Bank has predicted that Canadian Solar would earn total revenue of $574 million with a net income of $49 million. Also Deutsche Bank has also estimated that the market share of Canadian Solar would improve therefore NME can invest in the company to improve its earnings. Threats Increasing competition has been one of the major concerns and threats for Canadian Solar as there are several strong competitors in the international market threatening the company. Increasing prices of silicon has been another major threat for the company as it has been reducing the profit margin. Porters five forces Bargaining power of customer There are several customers for Canadian Solar around the world like automotive companies, consumer electronics, industries etc. therefore bargaining power of customers can be said to be moderate considering they have several competitors as well. Bargaining power of suppliers Suppliers of these companies include firms that provide raw materials like silicon, glass, cables and metals however there are other suppliers that provide specialised solar components to the manufacturers. With increasing silicon prices and suppliers provide specialised solar components therefore they have relatively high bargaining power. Threats of new entrants Because of large investment required to start such a business and specialised technological know-how, threats from new entrants are low. Threat of substitute products Because of low substitutes available, the threats of substitute products are low. Competitive rivalry within the industry There are several competitors in the industry so rivalry within competitors is high. Strategies and recommendations Improving Gross Profits One of the major concerns for the profitability of the Canadian Solar is that the profitability of the firm has been decreasing. The revenues of the company have been increasing but the major problem is that firm has not been able make its net income positive. The major cost of the company is the cost of revenues which mainly includes silicon. As the prices of silicon have been increasing over the years, it has increased the cost of goods or cost of revenues of the company. The following table summarizes the revenues and costs of the company In USD Millions 2006 2007 2008 Revenue 68.2 302.8 705 Cost 55.9 279 634 Gross Profit 12.3 23.8 71 Cost / Revenue 82.0% 92.1% 89.9% (Source: Mitchell, 2010) The following graph reflects the increasing cost of the company which has been the major factor for negative net income of Canadian Solar. (Source: Mitchell, 2010) Analysing Other Firms in the Industry Competitors are enjoying much higher gross profit margin in comparison to Canadian Solar and thus, Canadian Solar needs to do benchmarking in order to improve its profitability ratio by adopting techniques that competitors are using because of which they have lower gross profit margin. The following graph reflects the gross margin of different firms in the industry (Source: Mitchell, 2010) The major strategy for the firm is to take steps in order to reduce the cost and improve profitability. One strategy that can be implemented with constantly increasing prices of Silicon is that the company can hedge its cost particularly the cost of silicon. Hedging is defined as making an investment in order to secure from fluctuations in the price movements of an asset (Cullis, & Jones, 2009). If the company hedges its position, then it will be able to get silicon at the same rate regardless of what the price is in the market of Silicon and thus Canadian Solar could reduce its risk. So, Canadian Solar needs to find methods and techniques that other firms are using in order to achieve lower gross profit as Canadian Solar has a major difference in terms of gross profit against firms like First Solar, Suntech, Sharp and Kyocera. Forecasting It has been found that the forecasting or predictions made by the company is no way close to the reality. The company has not been able to predict the revenues, the costs and other expenses and thus the profitability that it would be making has not been predicted properly. According to company’s representatives the financial projections have surpassed a long way in comparison to what it was predicted at the time when business started and thus it clearly indicates that the management did not invest time in properly conducting research or even if they did, the findings of the research have not been reliable. Proper forecasting of costs, revenues and overall industry trends can be helpful in improving the profitability and achieving more consistent profits. Exchange Rate Risk Canadian Solar has faced losses in the last three years because of changes in the exchange rate. Firm that operates in more than one country particularly where different currencies are used; they face the risk of exchange rate. The losses faced by Canadian Solar have been represented in the following graph: (Source: Mitchell, 2010) The above graph shows that Canadian Solar sufferd a loss of $0.5 million in 2006 but then gained $2.7 million in 2007 and then suffered a major loss of $20.1 million in 2008. In three years, the net loss of Canadian Solar equals $17.9 million which is a substaintail amount. In addition to this, the average loss per year is almost $6 million (Mitchell, 2010). In order to mitigate this risk, Canadian Solar needs to make use of currency hedging in which investors are able to lock their prices of any currency and thus they are able to reduce their risk. (King, & Levine, 1993) Therefore with changes in exchagne rate, Canadian Solar would not be facing issues as it will be getting the same rate. However, Canadian Solar needs to consider the limitations of using currency hedging as hedging involves cost which can reduce the profit and it can limit the profitability that a company might earn because of changes in exchange rate. Gaining Competitive Edge There are several players in the market that have been dominating in the market and the industry has become highly competitive so Canadian Solar can differentiate itself from other firms in the industry. According to Micheal Porter generic model a firm needs to differentiate itself either through cost leadership or differentiation. Canadian Solar has to use the concept of differentiation to gain competitive edge. So, Canadian Solar could focus on one aspect and try to achieve specialisation rather than offering different products at the same time. Create a Diversified Portfolio Rather than Investing in one company Since NME would like to earn higher income on their investment and by investing in only one company the risk would increase, therefore it would be a good idea for NME to invest in different companies rather than investing only in Canadian Solar. So, if NME diversifies its portfolio by investing in different companies then it will be able to maximise its portfolio expected return and the risk of investment would also reduce. Product More than one product is offered by Canadian Solar, however the cost and quality of the product varies. It is important for Canadian Solar to properly evaluate the cost and benefit of each product and tries to identify the product which is more beneficial for the company and more profitable and invest more in it. Business Process Re-engineer is about analysing the existing system or design of the processes, methods, techniques and workflow of the organisation with the idea to improve it (Brealey, Myers, Allen, & Mohanty, 2007). Canadian Solar needs to use the same idea and it has to re-engineer its processes and identify areas where costs can be reduced but without influencing the quality of the product. Market The other important consideration for an international firm besides products is to choose the right market to enter. Although Canadian Solar has evaluated and shortlisted ten countries where they would be operating but at the same time they need to value each of the market and try to find which out of these ten markets would be the most profitable one. Canadian Solar needs to identify the potential and profitable of each market along with different factors that could influence their operations in that particular country. It is important to evaluate and forecast demand by keeping different scenarios like good, average and bad situations so that measures can be taken accordingly to mitigate the risks faced by the company even if things do not go as planned. Growth Vector Matrix Or Ansoff Matrix Ansoff Matrix is used to define and analyse the product and market growth strategy. As Canadian Solar would be focusing on ten markets showing higher potential and it will be going with the same product so Canadian Solar would be using the market penetration strategy by going with the same product and capitalising the opportunities in the existing market. (Source: Ansoff Matrix) Financial Recommendation With sales expected to grow and more opportunities available for Canadian Solar to capitalise, the profitability of the company is expected to improve as anticipated by Deutsche Bank. The company could improve its earnings and improve its profitability drastically by using the above mentioned techniques and thus it could become an important firm for NME to invest. Deutsche Bank the company to earn net income of $49 million along with sales of $574 million (Mitchell, 2010). Ethical Considerations It is important that firm follows ethical practices and does not get involved in activities which are unethical as firms which follow unethical practices are able to capitalise on short term earnings but in the long run such firms pay penalty for doing so therefore it is important that strategies adapted by the firms should be ethical. Also by being ethical, brand image of the company improves and customers are itself attracted thus improving profitability in the long run. conclusion NME should make investment in Canadian Solar as the industry has a lot of potential and with growing demand it would be beneficial and profitable. However it is important for Canadian Solar to improve its profitability and earnings by making use of the abovementioned recommendations in the report. The company needs to take steps and evaluate the positive and negatives of each strategy and then take actions accordingly. It should also prioritise things as the planning is one of the most important ingredients for the success of a company. References Ansoff Matrix, Ansoff Matrix.com. Available at < http://www.ansoffmatrix.com/> [Accessed 7 January 2012] Barro, RJ, & Sala-I-Martin, X 1992, ‘Public finance in models of economic Growth’, review of economic studies, vol. 59, no. 4, pp. 645-661. Besley, S, & Brigham, EF 2007, Essentials of Managerial Finance, 14 edn, Thomson Higher Education, USA. Brealey, RA, Myers, SC, Allen, F, & Mohanty, P 2007, Principles of corporate finance, McGraw-Hill, New York. Cullis, JG, & Jones, P R 2009, Public Finance and Public Choice: Analytical Perspectives, 3rd end, Oxford University Press, Oxford. 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