Time once again for an overheated pitch from our friend Louis Navellier… he’s been circulating ads for his Emerging Growth newsletter ($695/yr) that promote several of his favorite ideas for the year ahead, including a rehash of his lithium pick from a few months ago as well as this newer (to me, at least) “World’s First Solar Monopoly” pitch.
So let’s dig in, shall we? The basic spiel is that this is the raw material supplier that the solar companies depend on, and therefore as solar demand rises the demand for those raw materials (polysilicon for the solar panels, in this case) should go up.
Ready? Here’s a taste:
“China’s rapid expansion of renewable energy facilities is not only making headlines around the world but also minting millionaires. It’s no wonder. China is on pace for record solar installations in 2017.
“According to the International Energy Agency (IEA), China may end 2017 with year 123 gigawatts (GW) of capacity. That’s enough to power 20.2 Million U.S. homes!
“The pace of installations won’t end any time soon. China has made renewable energy a priority, not only offering subsidies but also low-cost loans as well.
“As a result, our no. 1 recommendation is well on its way to becoming the world’s first solar monopoly.”
Why a monopoly? Does no one else make this stuff? Here’s what Navellier says:
“It’s the lowest-cost producer of polysilicon for photovoltaic product manufacturers in the world who further process it into ingots, wafers, cells, and modules for solar power solutions.
“So, it’s no surprise their client list reads like a who’s who of China solar giants, including Jinko Solar, Meike Silicon Energy, Jinneng Energy, and JA Solar.
“This is why the company’s quarterly sales and earnings are skyrocketing, up 64% and 115% respectively.”
And he says there’s big growth ahead, with analysts forecasting 371% earnings growth in the fourth quarter of 2017… so that’s a good clue for our Thinkolator. And he says the stock is already up 127% year to date, by which he presumably means since the beginning of 2017, not 2018 (I got the ad this week, but it’s possible it’s been running for a while).
So who is it? This is, sez the Thinkolator, the Chinese materials comapny Daqo New Energy (DQ), which I confess to never having heard of before. They are, indeed, a manufacturer of polysilicon, with their customers being the big photovoltaic cell manufacturers.
I’ve owned polysilicon names in the past, though it’s been a long time since I looked at the industry — the last time I was excited about it was when solar panel manufacturing was just taking off, before the financial crisis, and there was a shortage of high-grade polysilicon because demand from both semiconductors and solar panels was growing at the same time. To illustrate the problem with getting the timing right in these industries, however, there was a pretty brief window of success before that company went into bankruptcy (it was MEMC Electronic Materials, which later became the foundation of SunEdison, which went whole hog on leveraged growth and eventually collapsed).
So what’s going on in that industry today? Well, if you like the long-term prospects then you may be in luck, because the new tariffs announced in Washington last week really brought a cloud across the face of the Chinese solar companies, including DQ, and the stock is down roughly 10%.
Those tariffs are pretty punitive, they’re calling them “safeguard tariffs,” and they essentially do what the US has been trying to do since 2011 (the Commerce dept. has already found Chinese solar panel exporters guilty of dumping in the US market, but the duties imposed were sidestepped by Chinese manufacturers moving their production out of mainland China). This ends up being really a benefit to First Solar alone, since no other major US solar manufacturers exist that I’m aware of, but the hope, I imagine, is that this convinces the solar multinationals to move some of their manufacturing to the US (as some Chinese firms have moved production to Germany, Korea, Taiwan and other countries in the past).
Will it have a major detrimental impact on the volume of solar cell manufacturing, and therefore on the demand for Daqo’s polysilicon? That I don’t know. The analysts from Goldman Sachs are quoted here as saying that the tariff’s will imply “a 3-7% cost increase for utility-scale and residential solar, respectively,” which could certainly impact the market but might not put the brakes on fully — clearly the huge demand for solar installation in the US has been driven both by government incentives and by sharply dropping costs for imported Chinese solar panels, and the solar installers are loudly predicting a huge collapse of this industry (which is, as you’ve probably seen, one of the faster-growing industries and a good source of employment growth)… so who knows, we may end up seeing some changes, the WTO may have something to say about it, and the policy could change. It also already has a pretty quick “ease-down” built in, with the tariffs dropping each year until they reach 15% in year four.
My preliminary assumption is that a blended price increase of 5% in one market, the US, is not going to be enough to destroy the sector, which continues to see high demand in many countries, spurred by government mandates and incentives (including in China, which is being more aggressive than most major countries in trying to cut back on pollution), though these are tight-margin manufacturing businesses and I don’t really know where the inflection point hits and the whole industry starts to be in trouble.
Right now, the solar panel manufacturers are doing just fine and most of them have margins that could presumably absorb some tariffs, though prices would also likely rise (the tariffs hit all importers to the US, presumably, not just the Chinese manufacturers)… and some have already announced new US manufacturing plans, like JinkoSolar (JKS). And while JKS has gross margins of about 12%, Daqo, which supplies one of Jinko’s major raw materials, has much higher gross margins above 40%.
Daqo, according to their quarterly presentation back in November is in the middle of a multi-year capacity expansion plan, which has they producing about 18,000MT of polysilicon now and boosting that by about 50% by the end of next year. The production cost is about $9/kg and their selling price was over $16/kg in the third quarter last year, so that’s why they had a big surge in earnings last quarter, and the combination of continued strong polysilicon prices and their capacity increases should keep their revenue and income rising pretty sharply — analysts do indeed expect 371% earnings growth in the fourth quarter of 2017 (though expectations for earnings growth beyond last quarter are much more muted at this point, presumably because of uncertainty over future pricing).
They aren’t alone in the industry, of course, there are lots of other major producers — including the much larger company GCL-Poly Energy Holdings (trades in Hong Kong at ticker 3800, OTC at GCPEF in the US, also valued in the neighborhood of 10X earnings), and several large multinational chemical companies are also polysilicon manufacturers (like Dow Corning with its Hemlock Semiconductor subsidiary, for example, and OCI and Hankook in South Korea).
So with what seems like a boom in new polysilicon capacity across many of the providers, the risk is probably just what the risk is with most basic materials companies: That capacity could get ahead of demand, bringing lower prices and hurting profitability of the raw material producers. I can’t claim that I have any idea where that inflection point might hit in the polysilicon market these days, but the underlying demand for polysilicon seems still to be rising… assuming that the global market doesn’t get seriously upended by this new US tariff.
My first reaction to all of this was that the US manufacturers of polysilicon might benefit from increased investment in solar here, though I don’t know if they’re competitive on price or if the tariffs will impact US raw material pricing (perhaps new US manufacturing capacity would use imported polysilicon, I don’t know), and that might lead me to the somewhat beaten down REC Silicon, which is a Norwegian firm but has its manufacturing plants in the US (trades in Oslo at REC, OTC RNWEY in the US), but it looks like they’re probably being hurt by their lack of access to the Chinese market and I don’t know anything specific about their prospects (they’re not profitable now, though market cap and revenue are very similar to Daqo). Hemlock is also a big US producer, apparently, though it’s hiding out in the huge skirts of Dow Corning. That’s not a recommendation, of course, I don’t own any of these stocks, it was just my first impulse when I started researching the sector.
If you just go by the published financials, Daqo is a pretty easy buy — analysts estimate $8.30 in earnings for 2017 (they probably won’t report final 2017 numbers for at least another month), $6.48 in 2018 and $7.21 in 2019, so there seems to be an expectation that the boom pricing of last year won’t be repeated (makes sense, if capacity is increasing at all the polysilicon companies, though perhaps that could be conservative if Chinese solar demand continues to be pushed by the government), and if you average that out to be $7ish in annual earnings for a few years that means you’re paying a forward PE of about 8. You’re not getting much certainty of growth, and there are clearly risks in a heated market, particularly for folks like me who don’t really have a handle on whether or not polysilicon is going to jump from a premium product at premium pricing to a glut market where they have to slash prices, but at that valuation you’re at least not paying for accelerated growth — you’re just assuming that the bottom won’t fall out of the market.
So, in case it’s not obvious from my comments above, you can get that “monopoly” bit out of your head now — it’s almost the opposite of a monopoly, it’s a manufacturer of raw materials for a growing sector, but it’s one of a great many manufacturers who have the capability of making similar wafers for the solar industry, and I don’t see any indication that it’s the strongest or the most advanced market participant (though it’s certainly not the weakest, at least, and may well be above average, I don’t know).
You can see Navellier’s snapshot here on Daqo from his public Portfolio Grader service, where the stock is unsurprisingly given an “A” grade, and then you can go forth, researchify, and think for yourself: Like the prospects for polysilicon suppliers in China? Think demand and pricing will remain robust? Worried about the downside risks? Let us know with a comment below.
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