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Quick Update on Jinko Solar (JKS)

There has been a massive run up in Jinko’s shares recently. Since my initial article on Jinko Solar, the shares have increased 300%. Such a dramatic increase warrants a renewed look at the underlying company. Until I embark on a more thorough analysis of the company, I will leave a chart beginning with the date of my last update on JKS and ending at the most recent closing price.

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The reason I believe in Jinko Solar (JKS)

Jinko Solar is the largest solar panel manufacturing by GW of panels deployed and sold annually. As more central governments develop stimulus programs an increasing caveat of these programs is a focus on clean energy. The rapidly declining price of solar makes it a viable alternative to traditional energy sources. However, what makes solar energy attractive for adoption is also a reason not to invest in it. Solar Panel manufacturing will likely go the way of P/C and become a commoditized product will low profit margins. Given that profit margins will inevitably decline substantially why do I believe in the company. Firstly, I believe there will be a significant increase in demand for solar panels given these new stimulus programs and policy changes. This will probably lead to increasing profits even with a decline in margins. Secondly, I believe the additional capital focused on environmentally conscious companies will lead to a valuation expansion for Jinko Solar. This should lead to a decent return in the intermediate term. The fact that I’ve bought into JKS American depository receipt and the passage of the “Holding Foreign Companies Accountable Act” will dampen this valuation expansion for the next few months until the bill is truly dead (or passed in which case the share price will suffer). Thirdly, Jinko Solar is already the largest solar panel manufacturing and with the economy in extreme distress smaller manufacturing firms will go out of business. This will increase the dominance of the larger players such as Jinko. While I believe this company will outperform in the intermediate term, once their primary product becomes commoditized margins will drop and handsome returns will be impossible, however until that occurs the company should perform fantastically.

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A passing thought on stocks

The divergence between the economy and capital markets has only grown since the Coronavirus pandemic. With interest rates on bonds so low stocks seem to be the last place for reasonable growth. Amazon issued $10 billion in debt recently with an interest rate of .4%. When private companies can borrow at the same rate as the Federal Reserve, the debt market really has nowhere to go. As more capital leaves the debt market and makes a home in equities, prices will continue to rise. The rise in stocks is not necessarily rooted in optimism but in the reality of probable returns.

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S. 945 “Holding Foreign Companies Accountable Act”

The senate unanimously passed this act yesterday. It’s amazing to believe the most polarized poltical body in the United States could agree to something so wholeheartedly. This amendment will have a material impact on the ADS (american depository securities) of foreign companies specifically Chinese companies. The major requirements of the bill are two fold

  1. The PCAOB must be able to regulate the company in subject’s auditor
  2. The Company must demonstrate that they are not owned by a central government

While many companies will be able to adhere to the first stipulation the bill was designed to exclude all Chinese companies from adhering to the second requirement. Considering the only position I currently possess is a Chinese security what does this mean for me.

Firstly, institutional investors will liquidate their equity shares in Chinese companies as a precautionary reaction to this bill. This will inevitably depress the share price of these companies significantly. Secondly, the uncertainty around the passage of this bill will lead to an immediate devaluation by the financial community of any Chinese security and will persist for sometime until the political reality becomes clear. Both of these reactions do not bode well for the short term performance of Chinese companies ADS price and cast doubt on their long term performance.

In reaction to this political escalation by congress I only have one option. Which is to liquidate my recently acquired position for a nominal change in value and be done with this affair. I do not like this option because I firmly believe Jinko Solar is well positioned to capitalize on the World’s transition to renewable energy. Their ability to manufacture high efficiency solar panels at extremely low costs represent a competitive moat that is difficult to overcome. Additionally the company is currently the largest manufacturer of pv-modules and would probably extend this lead over time. I also believe their relatively inexpensive panels represents an ability to strengthen margins over time and become increasingly more profitable over the next five years or so. Also by divesting from the actual solar projects themselves and focusing solely on the production of pv-modules they are focused on doing what they do best. It is an unfortunate political escalation which has both dramatically clouded their long term prospects and led to a real reduction in their market value.

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Jinko Solar Is a Fantastic Company trading Cheaply

Jinko Solar is currently the world’s largest Photovoltaic Module manufacturer. Their current manufacturing capacity of Jinko is roughly 40 GW . This demonstrates tremendous growth from just 8 GW a few years ago. The share price of the company has not reflected this amazing growth in capacity has not been reflected in it’s share price. Additionally, management continues to plan for increasing capacity during the economic downturn. This should demonstrate the resilience of the company. While China, the company’s domestic market, accounts for ~85% of their revenue, the company is expanding into EMEA and America. The potential of these new markets offers tremendous sales and profit growth for the company. A point of concern may be the stated low margin of 3% for the company’s products. However, this margin reflects sales of all the company’s products. Jinko, being a vertically integrated PV-module manufacturer sales many low margin products across it’s value chain. This does not reflect the true margin of close to 18% on the company’s primary offering. Another point of concern may be the heavy debt load of the company. While the debt load is natural for an industrial company of this size, the operating cash flow from the company’s sales is more than enough to cover these debts. The company also said that their customers have not asked for shipment delays during the pandemic.

The reason I believe the market has been so pessimistic towards Jinko Solar, is because the price of Energy is currently so cheap. However, this pessimistic view undermines the potential growth of the sector and the growth of the company’s PV modules sales over time. Also, the company has impressive return on dollars spent on R&D. The current sales of the company come from (I believe not 100% sure) about ~$200 million. These products now sell $6 billion dollars a year. This impressive return on R&D bodes well for the company. For example AMD had been cultivating a line of products with potential growth, however it was only years later these investments began to pay off. A similar story is unfolding here with Jinko.

I began buying Jinko Solar around $15 a share and increased my share as the stock approached $16. I believe these prices represent a significant margin of safety of around ~40%. This substantial margin of safety represents a good investment for the short time and a great investment over a longer time horizon. I believe as governments and energy companies begin expanding their solar projects demand for Jinko’s products will expand with this industry wide demand.

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My analysis of Spirit may have been flawed

The underlying assumption I made when analyzing Spirit was that it’s true value or prospective value had changed marginally in the pandemic. Warren Buffett’s announcement of selling all airlines lead me to question this belief. Here is a seasoned investor with a time horizon that is quite literally indefinite. If he doesn’t see a quick or inevitable return in demand, clearly something has fundamentally changed in the market. Another critical error in my analysis is ignoring Spirit’s high fixed operating costs. Reading a seeking alpha article that used Delta and United Airlines operating cost to measure what the fixed cost for an airline is, made me realize that although Spirt and Southwest are highly capitalized it will not be enough. There is no way they can be agile and maintain enough liquidity given their business models. Additionally with such a dramatic and sustained drop in demand it will be impossible to be agile and profitable. With this high level of uncertainty I believe there is not, currently, a sufficient margin of error for a purchase to be made.

So what could change that would make me buy Spirit? Firstly some evidence that the depressed demand will not last and high volumes may return within 12 months. It’s key, especially for Spirit, that volume returns within a year. If demand does not return within a year the company will need to issue significant equity financing. This issuance of stock will dilute shareholders’ stakes considerably. The other airlines will have to take this action significantly earlier than Spirit, but even this well capitalized company might need to as well. The macroeconomic trends will also affect Spirit’s equity price considerably over the next few years. If the country enters a prolonged period of slow or negative economic growth it may take more than a decade to recover volume levels.

Given all of this uncertainty there are clearly better areas to deploy capital. JPM and Google are two of the best managed companies and have exceptionally high returns on equity. JPM is consistently averaging 10%, Google is also boasting some of the largest growth and margins. Both of these companies are much more certain and definitely better areas to deploy wealth than airlines currently. However given the fluid nature of the crisis, airline stocks especially Spirit and Southwest warrants a close look if the market becomes extremely pessimistic about their prospects.

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Spirit Airlines is a Buy… Here’s why

Spirit Airlines will survive the Coronavirus crisis.  The company has $894 million in cash and has access to a revolving credit facility of $110 million which carries an interest rate of 2% plus the LIBOR and has the option to increase it to $350 million.  Additionally, the company is slated to receive $330 million through the Payroll Protection Program.  This means the company should have around $1.2 billion in liquidity with an option to increase it to $1.4 billion.  The company’s primary expenses are from labor and fuel which combined account for ~50% of operating costs.  The drop in oil prices and reduction in capacity will limit the $1 billion spent on fuel last fiscal year.  

Spirit has also cut costs by delaying capital investment and other expenses by $70 – 105 million before any savings from a reduction in capacity.  The company has stated that they reduced flight capacity by 80% in April and plan to reduce May capacity by 75%.  These reductions should help save a large portion of the $3 billion spent last year on operating costs.  Also, all tickets sold by the company are non-refundable,  limiting the potential cost of refunding passengers.  As long as Spirit can provide transportation, these pre-sold tickets will be recognized as revenue.  Assuming a national shutdown does not last for an additional year, the company has adequate liquidity to survive the crisis.  Additionally, Spirit is primarily a domestic carrier, meaning border shutdowns do not affect the company as adversely as it does the larger airlines.  

Now that the question of survival has been settled, what are the company’s prospects?  Currently, at a $13 share price, the company is trading at a price to ‘19 sales ratio of 1:5.  Additionally, the company’s market cap is currently below the cash value on its balance sheet.  However, the future of Spirit depends on factors largely outside the company’s control.  The first question is: When will people fly like normal?  The absolute latest time is when a vaccine or effective treatment becomes widely available.  The earliest time would be when the U.S. government reduces restrictions and allows carriers to operate normally again and people act indifferent to the pandemic.  The timeline on a return to normalcy is probably in the range of 3 – 14 months.  With the innate flexibility of Spirit’s corporate structure, the company should be able to significantly cut costs and conserve cash.  

However, will air traffic continue to increase after a return to normalcy?  Will people be too scared to fly again?  People tend to have a very short memory.  Now, I’m not an expert in cognitive psychology, but people cannot see the virus.  They cannot see buildings crumbling and a crater where one of the world’s tallest buildings used to be.  The lack of visceral images renders the virus’s emotional impact less then it might have been otherwise. This leads to a normalcy bias of people minimizing the potential threat to their health and a resumption of pre-Covid behavior.  Because of Ultra Low-Cost Carriers (ULCC), like Spirit, there has been continued passenger volume growth over the past decade.  While economic downturns tend to decrease total Air demand,  ULCCs tend not to be as adversely affected because of their inherent low-cost nature.  It does dampen growth by reducing their non-ticket revenue which has become a driver of growth over the past few years.  Over the past thirteen years, non-ticket revenue has grown tenfold and represents huge potential for the company.  While the growth of this part of the company may stall, it will continue after the crisis and be a principal driver in Spirit’s growth. 

The long term prospects of Spirit look bright.  Firstly, the company has not been bogged down by the production problems at Boeing, by flying a completely Airbus fleet.  The company “operat[es] a single-fleet type of Airbus A320-family aircraft that is one of the youngest and most fuel-efficient in the United States.”  This flexibility allows crews to be completely interchangeable and is ruthlessly efficient.  Additionally, the company can offer products significantly below the profitable price of other carriers.  The largest foreseeable risk is when larger airlines begin offering ULCC rates for a set number of seats in their planes at a loss to take back market share.  Such action may adversely affect Spirit’s ability to return outsized gains to its shareholders. 

Philip Fischer is regarded as an investing legend and wrote “Common Stocks and Uncommon Profits”.  In it, he delineated fourteen points which a company must possess if they will return significant value to shareholders over many years.  The points can largely be summarized into four categories: Potential for Sales Growth,  Margin growth,  Management’s ability, and Labor relations.  

The first question that must be asked is, what is Spirit’s potential for Sales growth. According to Statistica the total operating revenue of domestic airlines was $240 billion as of 2018. 

Spirit Airlines sales were only $3.4 billion in 2019 and with a potential market of $240 billion, there is significant room for sales growth over the next decade. 

The second point to observe is the future of the company’s margin.  The current net margin of the company is ~8%.  Such a low margin is not enticing, but Walmart and Costco succeed off of low margins with economies of scale and large volumes.  As a ULCC Spirit will have low margins initially but will grow as scale is reached and additional passengers serve as pure profit.  The ideal future for Spirit would be the American equivalent of Ryanair.  Ryanair is a mature European ULCC.  Ryanair initially had low net margins but grew them over time as scale was reached.  Currently, their net margin is ~ 12% which is 50% higher than Spirit’s current net margin.   

Ryanair net margin over time

From both a sales and margin perspective Spirit’s future looks bright.  The next two points of discussion are labor and management.  Most of Spirit’s workforce is unionized.  Additionally,  labor accounts for ~30% of operating costs and is extremely important to the Airline business.  Adverse labor relations would crimp growth and ruin a potentially great company.  However, given the preeminent position labor has in the company’s annual report, it should be safe to assume decent working conditions.  Given the company’s low-cost structure pay is below the market average and may not attract the highest quality employees.  My personal experience has always been positive when flying on Spirit and always had a positive experience with the employees.  

With regards to management the CEO, Ted Christie III, has been with Spirit since 2012. Historically, companies that have promoted insiders to the helm have outperformed their peers that brought in outsiders.  Also, the efficiency that Spirit operates with should testify to management’s capabilities. 

The market has severely mispriced a growth company at bare bottom prices.  Buying Spirit at its current price represents a great investment over the next decade.  The company is efficiently managing its resources and has ample opportunity to increase its sales and profitability.  The current market is pricing this wonderful company at criminally cheap levels.  

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Mitch Mcconnell … WOW

The house majority leader, Mitch Mcconnell, suggested that states should file for bankruptcy instead of seeking federal aid. It seems as though age old debates are never settled. States filing for bankruptcy is essentially the question of consolidating states debts into a national one. Nothing would be worse for American credit then letting the states file for bankruptcy. The interest rate on federal debt is low because people believe in the future of the American economy. What type of message is sent when the component parts of that government are allowed to fail? The United States is a nation of states. It adheres to the principal that one’s brothers are not left to fend for themselves. It is imperative that partisan politics are put aside to ensure financial stability for all Americans. To allow states to file for bankruptcy would be akin to flaying one’s brother on and idle hope.

All of the rhetoric is surely just posturing but even it’s discussion is damaging to the safety of American credit. There are competing global powers ready to seize on American weakness. Such divisiveness leaves an opening for America’s enemies and offers fodder for their claim to global leadership. It is imperative America projects a sense of unity to ensure a continued global order. There will be acute financial consequences if the dollar loses its preeminent position. The most severe consequence may be having American debt denominated in a foreign currency. Such a move would prevent the Federal Government from printing more money to pay its debt down. This is one of the principal reasons behind keeping the interest rate so low on American debt.

America needs to remember Alexander Hamilton’s message: consolidate state’s debts and give the union a financial diuretic. This can only happen if the political posturing ends and sensible discussion begins.

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Yesterday, I sold everything that I did not understand when I purchased it. I did this simply because I became aware of my own ignorance. Such ignorance should always be known  before a position is entered into. USO, the position I exited, dropped 25% today. I’m aware I lost a lot of money buying equity in a product I did not understand, but intelligence comes from mistakes. So hopefully I’m a slightly more learned person now. Fortunately I cut my losses before the 25% drop today. I believe USO will probably become delisted in the near future. Super Contango is a real problem and unlikely to go away soon. USO is being restructured to hold more distant future contracts but the losses will not be recovered. In the future, I will thoroughly understand what I purchase. This lesson was costly but hopefully unforgettable.

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A Lesson in Humility

I firmly believe that buying financial products that are poorly understood should not be purchased. I did not understand products tied to oil and I still bought them. This was a childish mistake, one I hope never to repeat. However, it is water under the bridge. Masha Son lost billions of dollars and seems to have a tenacity to persevere. I too hope to have this same strength and continue on. Following a rigid plan of analyzing what I purchase, delineating why I would purchase it, and knowing under what circumstances I would exit the position will be my process moving forward. I believe adhering, rigorously, to these stipulations that I will avoid the traps I seem to have repeatedly stepped in.