June 12, 2014

Solar Power Equipment Warranties:

First Solar and SunPower have emerged as major warranty providers, building megawatt power plants in the desert. And Tesla Motors, while not solar powered, has emerged as a major warranty provider in the "green" energy industry. They're still not as big as GE or GM, but they're no longer small either.

Of all the sources of alternative and renewable energy, solar power has proven its ability to scale up to the size of the coal- and oil-fired industries. And while some of the industrial giants of the last century have diversified into the renewable energy field, new market leaders are now emerging.

As can be seen by their warranty expense reports, some of the biggest names in solar power plant equipment and electric cars are getting large enough to deserve their own category separate from their coal-, diesel- and gasoline-powered peers. So this week we're going to take a look at their warranty metrics for the past 11 years.

We began with a list of 38 U.S.-based companies that manufacture some type of "green" energy equipment: solar, wind, biofuel, electric car, fuel cell, hydro, etc. And then we realized that we had to remove two companies from the list because of their tremendous size: General Electric Co. and General Motors Co.

Because many of the 36 remaining companies are small and young, if we had included GE just for its wind turbines or GM just for its Chevrolet Volt, we would have been averaging in a great deal of non-green warranty spending that would have overwhelmed the rest. We would have ended up simply averaging GE, GM, and other. Plus, we had already covered GE in the April 10 newsletter, and GM in the April 17 and March 27 newsletters.

Emerging Market Leaders

We almost took Applied Materials Inc. out of the mix as well, because while they have a full suite of solar power equipment-related products, there's also lots more to the company. And back in 2003 and 2004, those other product lines dominated the company's product line, while solar was just getting started. But we kept them in, because as we shall see, by the end of our 2003-to-2013 time period they had been surpassed by both First Solar Inc. and SunPower Corp. in at least one of our four warranty metrics.

For the 44 quarters from the start of 2003 to the end of 2013, we collected four essential warranty metrics for each company: the amount of claims paid, the amount of accruals made, the amount of reserves held, and the amount of products sold. And then, by dividing the first two metrics by the last, we derived two more: the claims rate (claims as a percent of sales), and the accrual rate (accruals as a percent of sales).

Then we divided the list into two groups: 14 manufacturers of solar power equipment, and 22 manufacturers of other types of "green" energy products. We'll drop the quote marks now, but the reason we're using them is because we're not sure if the electric car products of AeroVironment Inc. or Tesla Motors Inc. belong there if the source of the energy they plug into is ultimately a coal-fired electric utility. And then there's the question of whether biofuel production is really more environmentally friendly than oil or gas, when all the carbon emissions of production as well as usage are factored in. But for now, we'll drop those doubts, and we'll drop the quote marks.

In Figure 1, we're tracking the claims payments of the 36 companies over 11 years. Since the data is gathered quarterly, we are able to combine the data from the four calendar quarters of each year, no matter when a given company's fiscal year begins or ends.

As can be seen in the chart, the recession depressed claims payments in 2009, and they dropped once again in 2013. Overall, claims payments for the 36 companies in both groups peaked once in 2008 at $214 million, and then peaked again at $243 million in 2012. The most recent drop, however, can be pinned on two companies: Applied Materials cut its claims payments last year by $36 million, and First Solar cut its claims payments by $28 million.

Figure 1
Solar Power Equipment
Claims Paid by U.S.-based Companies
(in US$ millions, 2003-2013)

Figure 1

Several others actually increased their claims payments in 2013. For instance, Tesla paid out $19 million in 2013 as opposed to only $3.4 million in 2012. On the one hand, that's a sign of increased warranty work, which is bad. But on the other hand, product sales more than quintupled in 2013, so the company's electric cars are catching on, and inevitably more sales means more warranty work.

Of course, that means that Tesla accounted for more than half of the green group's total claims payments last year. And indeed, the electric car company is behind that group's rising claims total. Tesla's share was only 13% of the total in 2009 (the first year it reported paying claims), and was still only 20% of the $17 million total in 2012.

Extra Long Warranties?

The tricky thing about the warranty metrics of the green energy companies, however, is that some of the guarantees last an extra-long time. For solar power equipment, for instance, the product warranty can last 10 years, while a performance warranty on the output of the equipment can last as long as 25 years.

In other words, some of the manufacturers expect this gear to last a very long time. Translated into warranty metrics, that means they expect small claims totals when it's relatively new, and growing claims totals when it gets to be old. And that means setting aside a large amount of money now, to be spent slowly over the long term.

SunPower, for instance, set aside $40 million in accruals last year, while it reported paying only $8 million in claims. On a much smaller scale, Andalay Solar Inc. paid out $4,400 in claims but accrued $19,710 to provide for the long term.

First Solar, which has several projects under way where its equipment is being used to build huge solar energy power plants in the desert, is an exception to the rule. In 2013, claims fell to $33 million while accruals fell to $36 million. In 2012, claims actually exceeded accruals.

However, if we look at it over the long term, then even First Solar fits the pattern. From 2011 to 2013, the company set aside a total of $289 million in current-year and previous-year accruals (including changes of estimate), against claims payments of only $119 million. And as we shall see in Figure 5, that helped drive up its warranty reserves to new heights.

In Figure 2, we can see that 2011 was actually a record year for accruals in this industry sector. And sure enough, that was the year First Solar had to make an additional $132 million in accruals, in addition to its regular accruals of $22 million, to fund its projected future liabilities. But it was also a peak year for accruals by Applied Materials as well as Canadian Solar Inc. And it was the second-biggest year for accruals by SunPower.

Figure 2
Solar Power Equipment
Accruals Made by U.S.-based Companies
(in US$ millions, 2003-2013)

Figure 2

However, also note that industry-wide accruals in 2013 were once again over $250 million. Then again, that didn't happen because of anything the solar power equipment companies did. Their accruals were about the same in both 2012 and 2013. Once again, it was Tesla that did it: The company boosted its accruals from $10 million in 2012 to $61 million in 2013.

But as we mentioned, this massive increase in expenses was more than met by a massive increase in product sales. Tesla's accrual rate has actually remained quite close to three percent for each of the last three years. And its claims rate has fallen under one percent. In other words, sales are rising faster than expenses, so the expense rate is dropping.

Warranty Expense Rates

For the industry as a whole, the story on expense rates is more mixed. The solar power equipment producers are reducing their expense rates, as their product lines mature and as their actuaries become more accustomed to actual performance data. The others haven't yet stabilized, and haven't yet found their natural expense rates.

In Figures 3 and 4, we've taken the claims and accrual data from Figures 1 and 2 and divided it by product sales data, to calculate the two expense rates: the claims rate and the accrual rate.

Figure 3
Solar Power Equipment
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2013)

Figure 3

You'll notice that in spite of what we said about solar power equipment producers accruing more than they spend on claims, the two lines are relatively close together in Figure 3. This we would attribute to the maturity and diversity of the product line of Applied Materials, which has been in business for 46 years and which make much more than just solar products. If we were able to remove the company's non-solar warranty expenses, the space between the red and green lines would likely widen to where it is for several of the "pure play" solar manufacturers.

International Considerations

We should note that there's also a significant amount of solar power equipment produced by Chinese companies that aren't a part of these U.S.-centric charts. That list includes Suntech Power Holdings Co. Ltd.; Yingli Green Energy Holding Co. Ltd.; JA Solar Holdings Co. Ltd.; Hanwha SolarOne Co. Ltd.; Trina Solar Ltd.; and ReneSola Ltd., among others. So the 36 companies we're tracking are by no means representative of the world market.

And then there are numerous European producers as well, such as REC Solar ASA and Activ Solar GmbH, not to mention Siemens AG, which is the European equivalent of GE when it comes to production of wind turbines and other green energy equipment. All of these companies export to the U.S. as well.

However, most of the largest U.S.-based solar power stations being built for electrical utilities are using American-made equipment. For instance, both the Topaz Solar Farm and the Desert Sunlight Solar Farm in California, as well as the Copper Mountain Solar Facility in Nevada, and the Agua Caliente Solar Project in Arizona, are all using First Solar panels. And then the California Valley Solar Ranch north of Los Angeles uses SunPower equipment. In fact, among the largest U.S.-based solar power plant projects, based on megawatts of output, only the Mesquite Solar Project is using Chinese-made panels.

But then there is also a residential solar energy market, and this is where the importers have been more successful. There's actually a bit of a price war under way on that side of the business, as a glut of imports search for market share. And this has helped turn long warranties into a bit of a marketing tool, where the longer the better is the guiding rule. One wonders how many of these companies will be around in 25 years to pay claims on equipment they sell today.

Searching For Stability

But back to the expense rates of the manufacturers. In Figure 4, we've charted the claims and accrual rates of the other 22 companies -- the primarily small and young companies that make everything from fuel cells to windmills. As is obvious from the chaotic tangle of the plot lines, these companies are still seeking their own level, trying to balance actuarial predictions with experience, to find the right amount of accruals to make given the true claims cost.

Figure 4
Other "Green" Energy Equipment
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2013)

Figure 4

Keep in mind that because we're not including huge companies such as GE or Siemens in this grouping, Tesla ends up dominating the lot. Last year, Tesla all by itself accounted for 63% of the group's claims and 87% of the group's accruals.

So what might seem like emerging stability, with the claims rate holding steady at 0.8% and the accrual rate firming up at 1.6%, is really just a reflection of Tesla's own growing maturity. In a few years, unless the others in this category go through their own growth spurts, Tesla's warranty metrics and the group's averages will become the same.

Warranty Reserve Balances

The year-end balances in the warranty reserve funds of the 36 manufacturers are detailed in Figure 5. Again, Tesla accounts for the bulk of the "other" group's totals. And again, Tesla's growth plus the growth of the solar power equipment companies pushes the combined totals of the 36 companies to a new high of $528 million in 2013.

Also, while 2012 was the peak for claims payments by just the 14 solar power equipment companies (Figure 1), for some reason 2011 saw the peak total for both their accruals and reserves. But that probably has more to do with the timetable for construction of many of the major solar power plants than anything else.

Figure 5
Solar Power Equipment
Reserves Held by U.S.-based Companies
(in US$ millions, 2003-2013)

Figure 5

But this warranty metric is where the solar power equipment companies come to dominate the totals of their group. That's because as they continue to accumulate accruals that aren't immediately spent on short-term claims, their warranty balances continue to grow.

As was mentioned, mature and established companies such as Applied Materials dominated the warranty metrics totals in the early years of these charts. And that is still the case with claims, and to a lesser extent with accruals.

New Market Leaders

However, it is no longer the case with warranty reserves. In 2013, First Solar and SunPower accounted for just 25% of their category's claims (Figure 1) and 42% of their category's accruals (Figure 2). But in terms of reserves, these two companies accounted for 76% of their category's total (Figure 5).

A better way to show that might be to compare some of the top green energy company's year-ending warranty reserve fund balances. In Figure 6, we've included both First Solar and SunPower, along with Applied Materials and Tesla. We also included Energy Conversion Devices Inc., which was a major producer of solar cells and batteries until it filed for bankruptcy in 2012.

Figure 6
Solar Power Equipment
Reserves Held by Top Five Companies
(in US$ millions, 2003-2013)

Figure 6

As can be seen in Figure 6, at certain points back in 2003 to 2006, Applied Materials accounted for up to 94% of the entire group's warranty reserves (e.g. $138 million out of a $148 million total at the end of 2003). By the end of 2009 its "market share" was under half, and by the end of 2011 it was under a third. Its share at the end of 2013 was under 20%.

Meanwhile, there was no warranty data available in 2003 for either First Solar or SunPower. Neither began reporting their warranty expenses until 2004. And they didn't account for even 10% of the industry's warranty reserve "market share" until the end of 2007.

Then things began to take off. Their combined share grew to 25% by the end of 2009 and to 50% by the end of 2011. By the end of 2013 their combined share was approaching two-thirds ($347 million out of a total of $528 million).

Top 100 Warranty Providers

In fact, both companies are now among the 100 largest U.S.-based warranty providers in any industry, as measured by their year-end 2013 warranty reserve fund balances. Besides Applied Materials, and of course GE & GM, the only other green energy product manufacturing companies to ever reach that level were Canadian Solar and Energy Conversion Devices. Cypress Semiconductor came close to the top 100 in 2007, and Tesla might make it onto the list in 2014.

The rest of the U.S.-based green energy companies, at least in terms of their warranty expenses, are relatively small. Some, such as Andalay Solar, are still measuring their warranty expenses in the thousands, as opposed to the millions. But First Solar and SunPower are now definitely in the major leagues, as is Tesla Motors.

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