Daqo New Energy: On Track To Double By Q2 2015

Aug.18.14 | About: DAQO New (DQ)

Summary

Daqo delivered a solid Q2 with accelerating sales and earnings.

Company's cost reduction and manufacturing expansion roadmap is intact.

We see the potential for the stock to double as the Company ramps up its manufacturing capacity by end of Q2 2015.

DAQO New Energy (NYSE:DQ) announced its second quarter results on Friday. While the results are a great improvement over the first quarter results, it is hard to find much information about Daqo given the limited coverage from Wall Street and there are no consensus estimates available for the Company.

The earnings came in $0.03 shy of our estimate of $0.60 largely due to lower polysilicon output for the quarter as well as a significant drop in ASPs in the Company's wafer business. The ASP shortfall is a result of soft Q2 Chinese market and the US tariffs which caused a disruption in the solar supply chain.

Setting aside the drop in wafer pricing, the Company performed admirably well on all operating metrics (see chart below).

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Management reported that the Company is seeing a slight drop in polysilicon ASPs in the quarter and is seeing above normal inventories at customers for wafers. The slow H1 in China is consistent with our view of the solar market and we believe the China solar demand is likely to strong for rest of the year.

So, while some investors may worry about the Company's commentary on current channel conditions and ASPs, we believe this is a non-issue. Also, in a surprising development last week, China announced a new trade policy on polysilicon that benefits domestic poly manufacturers. The new policy, set to become effective September 1st, closes a polysilicon import loophole and increases demand for domestic poly. This ruling increases tariffs on polysilicon imports and is likely to improve the ASP of domestic manufacturers like Daqo. A confluence of this ruling and the improving China market demand in H2 implies that the average polysilicon pricing in Q3 to be roughly flat with Q2 and may increase further in Q4.

Daqo's key strength, as we have written in the past, continues to be its ability to produce poly at lower cost than any of its peers in the industry. The chart below shows the Company's continued execution on this path in Q2.

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Management guidance suggests continuing cost improvement through rest of the year and we fully expect the Company to meet its guidance.

Perhaps the most important news coming out Daqo's second quarter conference call is the reiteration of production timeline for the Company's new manufacturing expansion. This expansion doubles the capacity by Q2 2015 and is likely to double its profits from the current level.

Assuming decent execution on the Company's manufacturing roadmap, our model suggests Q3 earnings of $0.62, Q4 earnings of $0.66, FY15 earnings above $4, and FY16 earnings in excess of $6. Based on the earnings trajectory and the Company's cost leadership position in the industry, we see the potential for the stock to double in the next 12 months.

Considering Daqo is a Chinese microcap operating in the volatile solar industry, the stock may be unsuitable for conservative long term investors. However, for investors with the appropriate risk profile, we view the Company as a top short to midterm Chinese solar pick along with JinkoSolar (NYSE:JKS) (see thesis), Trina Solar (NYSE:TSL) (see thesis) and Canadian Solar (NASDAQ:CSIQ) (see thesis).

Our sentiment: Buy

Disclosure: The author is long DQ, JKS, TSL, CSIQ. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.