S&P Assigns 'BB' L-T Rating to Canadian Solar (CSIQ); Outlook Stable

Standard & Poor's Ratings Services said that it had assigned its 'BB' long-term corporate credit rating to Canadian Solar Inc. (CSI)(Nasdaq: CSIQ). The outlook is stable. At the same time, we assigned our 'cnBBB-' long-term Greater China regional scale rating to the company. CSI is a Canada-based solar company with most of its production capacity in China.

"The rating reflects our view that CSI will continue to face intense competition and significant pricing pressure in the globally fragmented solar market," said Standard & Poor's credit analyst Tony Tang.

Like its peers, the company has a limited ability for product and service differentiation, in our view. The solar market is also highly dependent on government subsidies to drive demand. These factors have led to high volatility in CSI's profitability, and are likely to continue to constrain the company's business risk profile. In addition, we expect CSI's debt leverage to increase materially over the next two years because of its new strategy of holding solar projects through a yield company rather than selling them.

These weaknesses are tempered by CSI's good cost position, adequate technology and product quality, high operating efficiency, and position as the largest solar module supplier globally.

We expect business volatility to remain high for the next two years because of intense competition and frequent oversupply, which is partly due to low technology and capital barriers for new entry or expansion. Nevertheless, we believe the volatility could moderate in view of market consolidation and greater geographical diversification in end markets. We also believe that the solar market's high dependence on government subsidies to stimulate demand subjects the industry to policy uncertainty.

We expect CSI to continue to grow its market share, given its low cost structure and good operating efficiency, as shown by its high capacity utilization and good product quality. The company has rapidly increased its market share in the global solar market, becoming the largest solar module manufacturer worldwide with a market share of about 9% in 2014.

CSI's strategy of limiting investments in more capital-intensive upstream wafer and solar cell manufacturing also enable more flexibility in the company's cost structure and helps it to react fast to changing market conditions, in our view. In addition, the company's further expansion in China will continue to support its low cost structure. Accordingly, we expect CSI to maintain better profitability than most solar peers. However, we also anticipate that CSI's profitability will remain volatile because of still-volatile market conditions. This is despite our view that relatively
stable cash flow from electricity revenue will slightly moderate the high volatility in CSI's profitability if it successfully builds its yield company. In addition, the concentration of CSI's production facilities in China could expose the company to trade disputes between China and developed markets. Based on those factors, we assess CSI's business risk profile as "fair."

We expect CSI to maintain its control over the yield company and consolidate the subsidiary in its financial reporting after its listing. As a result, we will analyze CSI's business risk and financial risk profiles after consolidating the yield company, including non-recourse project finance loans at its solar projects. We expect CSI's yield company to benefit from CSI's strong project pipeline and its significant presence in developed markets with the injection of quality solar projects. We also believe that stable and transparent regulatory environments in developed markets and high-quality counterparties of power purchase agreements for CSI's solar projects will help the yield company generate relatively stable cash flow. Tempering these strengths are the yield company's concentration in solar power, initially limited scale, and lack of operating track record. Regulatory uncertainty, particularly in developing markets, is an additional risk. Further, we expect solar module manufacturing to contribute the majority of CSI's EBITDA for two to three years after the yield company is established. Based on those factors, we do not expect the establishment of the yield company, if it materializes, to significantly alter CSI's business risk profile.

We expect CSI to increase its ratio of debt to EBITDA to 2x-3x during 2015-2016 from 1.3x in 2014 for high capital spending related to the construction of solar projects that it plans to hold and the capacity expansion of solar module manufacturing in China. Our base case assumes that CSI will complete the IPO of its yield company in early 2016 and raise additional equity capital in 2017. We also believe the company can maintain its profitability from its module sales amid rising demand. Capital expenditure is likely to decline after peaking in 2015 for the launch of CSI's yield company. However, we expect that volatility in the company's cash flow and leverage ratios will remain high, given high anticipated volatility in the company's profitability through business cycles. This will add extra financial risk for the company, in our view.

If the IPO does not materialize, we expect CSI to dispose of the solar projects it develops and holds for the yield company and keep its ratio of debt to EBITDA comfortably below 3x. This estimate is based on CSI's long track record of developing and selling projects to investors and our expectation that the market for solar power energy projects should remain favorable. We believe that the company can sell the projects in several quarters without significant difficulty once it decides to do so. CSI generated US$892 million in revenues from the sale of solar power projects in 2014. We believe that its acquisition of Recurrent Energy will further add to its capacity for project disposal. In this alternative scenario, we believe that the financial risk profile assessment is not different from the base case. Based on these factors, we assess CSI's financial risk profile as "significant."

"The stable outlook for the next 12 months reflects our view that CSI can maintain its cost competitiveness and relatively stable profitability, and moderately increase its market share amid rising demand," said Mr. Tang.

We also expect CSI to increase its ratio of debt to EBITDA to 2x-3x in 2015-2016 because of its strategic move to hold solar projects through the injection of power assets into a separate listed yield company. The stable outlook also assumes that CSI will be able to sell projects to be held under the yield company and keep its ratio of debt to EBITDA comfortably below 3x in 2016 if CSI fails to launch the yield company as planned.

We may raise the rating if CSI strengthens its cash flow and keeps its ratio of debt to EBITDA below 2x. This could be achieved if: (1) CSI significantly strengthens its profitability with lower volatility through enhanced technology and product portfolio that strengthens its pricing power; and (2) the company can limit its capital spending by enhancing capital efficiency and lower its debt without hurting its competitiveness.

We could lower the rating if we believe that CSI's ratio of debt to EBITDA stays above 3x for an extended period. The scenarios that could lead to such deterioration include: weakening profitability stemming from unexpected industry downturns or a weakening competitive position, aggressive capital expenditure, significant additional working capital needs, or CSI continuing to hold project assets without spinning off the assets and listing the yield company. We could also lower the ratings if CSI's business risk profile deteriorates materially because of a substantial weakening in the company's technology and cost competitiveness, or heightened industry risks associated with trade disputes or unexpected changes in government energy policies in major markets. A return on capital of below 8% or high volatility in CSI's profitability could indicate such deterioration.

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