http://www.wsj.com/articles/solar-giant-hanergy-requires-extra-sunscreen-1420444057

Solar Giant Hanergy Requires Extra Sunscreen

Hanergy Thin Film Power Group shares almost quadrupled in 2014, becoming the world’s largest solar power company by market value.REUTERS

ABHEEK BHATTACHARYA

Updated Jan. 5, 2015 9:30 a.m. ET

A little-known Hong Kong-listed firm has come out of nowhere to become the world’s largest solar-power company by market value. A tight relationship with its parent company should give investors reason to worry whether its time in the sun will last.Hanergy Thin Film Power Group shares almost quadrupled in 2014. Its market capitalization of $14.4 billion now roughly equates to those of the three largest solar companies in the world— SolarCity , Sun Edison and First Solar —combined.

Hanergy shares especially picked up pace starting in October, when other solar stocks fell as oil grew cheaper, making renewable energy look less competitive, at least on the surface. Mainland investors who now have fresh access to Hanergy through the Shanghai-Hong Kong Stock Connect program could explain some of the demand.

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Yet Hanergy now commands about 53 times trailing earnings, a remarkable premium to New York-listed First Solar’s 17 times and Hong Kong-listed GCL-Poly Energy ’s 25 times.

Hanergy’s earnings seem robust. The firm makes equipment used to manufacture a niche type of solar panel known as thin film. In the year to June, it clocked gross margins of 85.1% and net margins of 53.8%, levels unseen elsewhere in the ultracompetitive solar world. First Solar, also involved in thin film, achieved only 22.5% gross margins and 8.6% net.

On a closer look, however, that profit is mostly on paper. Hanergy’s operations lose cash because it isn’t getting paid in time by its biggest customer: its parent.

As of June, the listed Hanergy had racked up receivables worth 1.4 times its revenue for the year before, nearly all due from the parent, Hanergy Holding Group. The parent, which owns 73% of the listed company, says it is China’s largest closely held renewable-energy firm, with interests in hydro and wind, along with solar. It buys equipment from its listed arm to build the actual solar panels.

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It presumably pays a high price for this equipment, given the listed company’s margins. That is all the more surprising since, according to CLSA’s Charles Yonts, these panels use a costly variant of thin-film technology that has mostly been abandoned by other makers. One risk is that the terms of these related-party transactions become less generous to the listed company.

There are other ways the parent and the listed company are entwined. The parent sells some completed panels back to the listed firm for the latter’s smaller business of installing solar farms in Ghana and China. Though these farms have secured contracts to supply electricity, this business is currently unprofitable.

Down the road, Hanergy’s next-generation thin-film technology has potential. But the technology is unproven, and the only major producer, in Japan, is still hobbled by high costs, notes Mr. Yonts.

Investors should think twice about buying into Hanergy’s rally, including those who may be exposed through index funds. The Guggenheim Solar ETF , a popular passive way to invest in the industry, counts Hanergy for 11% of its fund. Downward pressure remains from short sellers, even after some may have gotten squeezed in the latest rally.

Hanergy shares promise the sun. Shareholders, however, could find themselves in the dark.