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Avinash Gandhi

LDK AT A GLANCE

P/E ► 18.2 AVG EV/EBITDA ► 14.1 AVG ROA ► 4.5% AVG ROE ► 9.6% AVG Debt to Equity ► 3.35 VERY HIGH Current Ratio ► 0.819 VERY LOW Interest Coverage Ratio ► 3.19 AVG

 

 

 

 

 

 

LDK Solar is a Chinese company that sells multicrystalline polysilicon wafers to solar panel manufacturers, holding 8% of this market in 2006.^[1] With a number of new supply contracts, ranging from 3-year, fixed price to 10-year, take-or-pay, LDK saw growth in each quarter of 2007. With margins over the last year consistently above 30%, it's clear that LDK's strategy of using cheaper, recycled polysilicon to produce its wafers in a low-wage, Chinese environment is paying off by keeping costs down without affecting wafer quality.^[2] 63% of LDK's revenues come from Asia, with almost half that coming from China, while another 27% comes from Europe.^[3]. The rest comes from North America, a still-emerging market for renewable energy technologies, and a region with high future growth potential.

Demand for LDK's wafers is greatly affected by demand for solar panels. Rising oil and gas prices, fears of climate change, and political support for alternative energy sources are all playing a part in helping the budding solar market develop. Countering these forces, however, is a shortage of refined polysilicon, which is the principal input needed to produce multicrystalline wafers and solar panels. This shortage has driven up prices for all three, making solar energy less appealing than other power sources. LDK's main competitors in the multicrystalline silicon wafer market (with 2006 market share) are Renewable Energy Corporation (24%), SolarWorld AG (19%), PV Crystalox (17%), Kyocera (13%), and Sumco Corporation (6%).^[4]

Business Financials

LDK sells multicrystalline silicon wafers used primarily in the production of photovoltaic solar power cells. It also offers production services to other wafer manufactures. Multicrystalline silicon wafers are refined from multicrystalline ingots and blocks; LDK buys polysilicon feedstocks from silicon producers and refiners like MEMC, turns them into multicrystalline blocks, and either sells them to other wafer manufacturers or produces its own wafers to sell to solar panel producers.

LDK is greatly affected by the silicon industry. The silicon industry is essentially a commodities industry: one company's silicon can only be differentiated from anothers' by price.

The multicrystalline wafer industry works similarly. As long as a wafer is pure enough to work effectively, customers will purchase based on price, making the industry subject to low profit margins. LDK remedies this by producing in China (taking advantage of low labor costs) and by using scrap and recycled polysilicon (taking advantage of low-priced inputs) to keep costs down and bring margins up.

LDK's growth has been tremendous over the past year; the company has made a number of strong contracts with solar customers, including^[5]:

• A 10-year supply contract with privately-owned solar superpower Q-Cells for 6 GW worth of wafers, whereby Q-Cell pays 10% upfront and must also pay if it wishes to cancel a shipment

Fixed price contracts are good for the company if silicon wafer prices fall in coming years, as they allow the company to make more money than it would without the contract. If price levels rise, however, the company could miss out on potential revenues.

In 3Q07, LDK sourced 30% of its revenue from China, 33% from the rest of Asia, 10% from North America, and 27% from Europe^[6]. This breakdown can be attributed to the fact that a number of solar power companies, emerging and established, are based in Asia and Europe, while relatively few are in North America. Examples include China's Suntech Power Holdings, Solarfun Power Holdings, and Chinalight, as well as Germany's Q-Cell.

Source: January Investors Report^[7]

Note that, despite greatly increasing sales and profits, fast growth in the multicrystalline wafer industry has led to decreasing wafer prices, depressing LDK's margins over time.

Trends and Forces

Demand for LDK's Wafers Follows Demand for Solar Power

Solar power is a rapidly emerging form of energy production that converts light (usually from the sun) into electricity through the use of photovoltaic (PV) cells. PV cells are typically made from multicrystalline wafers; in fact, they are the only major source of demand for multicrystalline wafers. Thus, demand changes in the solar industry are equivalent to demand changes for LDK's business.

Increasing Oil and Gas Prices Could Make Solar Panels More Appealing

Oil and gas are non-renewable resources and the growing world dependence on oil and gas means a constantly decreasing supply. With oil hitting $100 per barrel on January 2nd of 2008, and assuming that oil prices stay high, the demand for alternative energies, such as solar, is expected to increase significantly in coming years. High energy prices are driving a search for renewable energy sources to power the expanding world economy. Solar power is one such renewable source; the sun will not stop emitting light for another 4-6 billion years, and it releases far more than enough light in a day to power the entire planet. Continued growth in the solar industry bodes well for photovoltaic wafer dealers like LDK.

LDK Hedges Against High Virgin Silicon Prices By Using Scrap Silicon

Silicon, a necessary input to most solar panels (and to the multicrystalline wafers that LDK produces), is one of the most abundant elements on Earth, but has nonetheless experienced rising prices over the last few years. As solar power started to popularize, silicon producers, who previously catered only to the semiconductor market, experienced a surge in demand - a surge they couldn't keep up with, given the limited amount of mining and processing capital on hand. This created a "shortage" of refined polysilicon, and caused prices to soar. For multicrystalline vendors like LDK, higher silicon prices mean higher costs and lower margins. Furthermore, a short-run spike in silicon prices would lead to a spike in solar panel prices, causing solar energy to be less competitive when price-compared to other sources of energy. LDK remedies the high-price problem by using recycled and scrap polysilicon as an input; with virgin silicon priced from $150-200 per kilogram and scrap priced from $50-$80 per kilogram^[8], the savings from such a strategy are considerable. LDK believes that it can produce multicrystalline wafers of premium quality despite the use of non-virgin polysilicon; given the number of recent supply deals with major solar manufacturers, its quite possible the company can.

Prices will not rise forever, however, as high silicon prices create incentive for more companies to enter the silicon wafer market; eventually, demand will be met. Even better, there are delays in prices changes, which could cause companies to continue to enter the silicon wafer market, thereby creating an oversupply and causing prices to drop (hence, the cyclical nature of commodity prices). Once prices drop, demand for solar cells could increase, as would margins for multicrystalline wafer companies.

Government Support for Renewable Energy is Vital to the Growth of the Solar Industry

Governments worldwide have implemented legislation to encourage alternative energy production, due to political pressure from public concerns about climate change and energy independence. Examples include:

• California's mandate that 25% of electricity come from clean sources by 2020 and 75% by 2050
• California's One Million Solar Homes initiative that gives subsidies to developers to build fully solar powered homes
• The European Union's stated desire to get 22% of its energy from clean sources by 2010
• China's Renewable Energy Law aiming to raise the total percentage of renewable energy used in the country to 10% by 2020

Emissions caps and clean energy mandates that are supported by subsidies and tax cuts make solar energy relatively cheaper. This means that corporations and utilities companies may turn to clean energy sources to generate electricity for manufacturing facilities and power plants, directly benefiting solar power producers and input suppliers like LDK. Without government support, however, solar companies would have difficulty vending their products, as solar energy is currently much less cost effective than coal or natural gas.

Environmental Concerns Are Major Drivers in the Renewable Energy Movement

Oil and coal power are the two main energy sources for most of the world and release massive amounts of pollutants that contribute to adverse environmental effects such as acid raid. With a rising worldwide demand for energy, demand for clean forms of energy have risen. Solar energy is fairly clean, as photovoltaic panels release no pollutants or emissions (except in production). Clean energies like solar energy have experienced increasing demand , especially in politically=progressive regions like Europe.

LDK is in Prime Position to Exploit Chinese Growth

In late 2007, China surpassed the U.S. as the top polluter in the world and there is increasing international pressure for China to adopt clean energy. China utilizes coal because it is cheap and bountiful but that energy source currently produces a large amount of pollution. With 30% of its revenues coming from China, LDK could be in a strong position to benefit from the potential growth of the solar market in China.

Competition and Market Share

The multicrystalline industry, in which LDK held an 8% market share in 2006^[9], includes the following key players:

• Kyocera - A diverse electronics and semiconductor company that held 13% of the multicrystalline market share in 2006 and produces, among other things, solar panels, consumer electronics products, and telecommunications equipment.
• Sumco Corporation - A Japanese silicon company that produces wafers for semiconductors and solar panels, and held 6% of the multicrystalline market in 2006.
• PV Crystalox - A British solar wafer company that is also involved in the Japanese silicon trading business. In 2006, PV Crystalox held 17% of the multicrystalline market.
• SolarWorld AG - A vertically organized German solar company that operates in all levels of the solar industry, from raw materials to module sales. The company had a multicrystalline wafer market share of 19%.
• Renewable Energy Corporation - The multicrystalline market leader, this vertically organized solar company had a 2006 market share of 24%.

Other, smaller companies comprised the last 13% of the 2006 multicrystalline market.

Notes

1. ↑ CIBC Initiating Coverage on LDK, July 18th, 2007
2. ↑ http://media.corporate-ir.net/media_files/irol/19/196973/new_Jan_2008_FINAL.pdf
3. ↑ http://media.corporate-ir.net/media_files/irol/19/196973/new_Jan_2008_FINAL.pdf
4. ↑ CIBC Initiating Coverage on LDK, July 18th, 2007
5. ↑ http://media.corporate-ir.net/media_files/irol/19/196973/new_Jan_2008_FINAL.pdf
6. ↑ http://media.corporate-ir.net/media_files/irol/19/196973/new_Jan_2008_FINAL.pdf
7. ↑ http://media.corporate-ir.net/media_files/irol/19/196973/new_Jan_2008_FINAL.pdf
8. ↑ http://209.85.173.104/search?q=cache:Pk4namaKEoMJ:www.babsonenergy.com/assets/Solar_Nakul%2520Munjal.ppt+silicon+price+kg+virgin&hl=en&ct=clnk&cd=2&gl=us&client=firefox-a
9. ↑ CIBC Initiating Coverage on LDK, July 18th, 2007