Recently Daqo New Energy (DQ) revised its second quarter earnings guidance downward to reflect the more dramatic pricing declines witnessed in the solar industry since May. While a warning on pricing levels isn’t a large surprise, DQ’s lowering of downstream shipment volumes indicates the company’s new line of downstream silicon wafer and solar module products are in a lower tier category and thus more vulnerable to industry demand dynamics than higher tier counterparts. As noted in my recent China Synergy (CSUN) article, less established lower tier producers are facing higher pressure in placing products in a generally oversupplied market. It is much easier to determine which are among the top tier suppliers but the dividing line becomes more gray when evaluating second and third tier companies. Apparently, Daqo’s warning suggests the company is in a much lower tier group since it was not even able to fulfill the low downstream volumes it originally guided.
For the second quarter of 2011, Daqo now expects revenues to fall between $70-71m with shipments comprising of 970-990 metric tons of polysilicon, .7mw of silicon wafers, and a total of 12mw of module products. This compares to an original guidance of $92-95m in revenues based on 950-1000 metric tons of polysilicon, 7mw of silicon wafers, and a total of 16.5mw of module products. Clearly, DQ’s original polysilicon shipments remain intact while large downward revisions were made in silicon wafer and solar module shipments.
The company’s new guidance does not detail how much of its outsourcing module shipments are fully internally produced white label or just OEM module processing services. DQ indicates 4mw are company branded which imply internally produced modules. However the remaining 8mw are just listed as outsourcing volumes. Without the exact composition of pure OEM module processing volume, it’s impossible to estimate the exact revenues generated. Since absolute volumes for Daqo’s downstream products are still very small, the earnings impact is not as dramatic although higher revenues could be generated above my estimates below with higher ratios of white label OEM shipments.
Until Daqo can utilize a higher portion of its wafer and module capacity, the majority of its earnings will rely on its polysilicon division. From the company’s revised guidance, polysilicon shipments are generally within original expectations. After factoring out implied revenues generated from the company’s downstream verticals, it appears average selling prices (“ASP”) for polysilicon in the second quarter is approximately 5%-10% lower than originally expected. Given much of the ASP erosion across all crystalline solar verticals occurred after Daqo gave its original Q2 guidance, lower ASP expectations are to be expected.
In general, most of Daqo’s revenue miss is due to shortfalls in downstream silicon wafer and solar module shipments while most of the company’s earnings reduction is related to lower polysilicon ASPs. Since my earnings estimates for companies are mostly within guidelines set by each company, I have to revise my Q2 2011 earnings estimate for Daqo after this pre-announcement. The figures below represent my new estimates which are based on DQ’s updated guidance.
DQ Q2 2011 Revised Earnings Estimate:
Shipments: 980mt polysilicon, .7mw wafer, 4mw module, 8mw oem
Asps: $60/kg polysilicon, .62/watt wafer, 1.40/watt module, .45/watt oem
Unit Cost: $29/kg polysilicon, .51/watt wafer, 1.25/watt module, .40/watt oem
COGS: $28.4m + $.4m + $5m + $3.2m = $37m
Gross Profit: $31.5m
Gross Margin: $31.5m / $68.5m = 46%
Operating Expenses: $4m
Net Interest Expenses: $2m
Net Income: 21.5m
Diluted Share Count: 35.3m
As with all my earnings estimates, the estimates above represent only operational earnings which exclude non-operational items such as net foreign exchange translations or other unannounced gains or charges. Since the vast majority of Daqo’s business is domestic, any net foreign exchange translation should be very small especially since movement in the currency market was much less pronounced in the second quarter relative to the first quarter.
While my new estimate of a .61 Q2 EPS is much lower than my prior .78 Q2 EPS based on DQ’s original guidance, it just reflects a faster normalization to current market dynamics. As noted in my prior Daqo article, quarterly earnings levels would have to come down as polysilicon ASPs normalize toward $50/kg or even toward $40/kg. DQ shareholders thus should expect quarterly EPS to trend toward .50 per share as lower polysilicon ASPs become factored into the company’s earnings.
However DQ’s latest warning does not change its normalized earnings outlook for the year as long as the original normalized metrics remain intact. If polysiilcon pricing can stabilize at around $50/kg, then DQ would not require too much additional incremental earnings from its downstream silicon wafer and solar module verticals to achieve a quarterly .50 in EPS. As I had noted, even if polysilicon pricing dropped toward $40/kg, Daqo could still keep quarterly EPS around the .50 level if the company was able to fully utilize its downstream capacity. Given this Q2 warning, however, the ability for Daqo as a lower tier supplier to achieve full wafer and module utilization in an oversupplied market remains extremely questionable.
As a result, Daqo’s quarterly earnings power could drop toward .30 in EPS if solely reliant on its core polysilicon business based on pricing toward the $40/kg level. The more the company can utilize its wafer and module capacity, the more incremental net income it could generate above and beyond this .30 quarterly EPS benchmark. Full utilization could improve quarterly EPS toward a .50 level. Thus without additional capacity (additional polysilicon capacity coming online in 2012), a normalized annual EPS for DQ might range between 1.20-2.00 per share. Annual 2011 EPS would still be higher since first half earnings would not fully reflect normalized levels. As with most U.S. listed Chinese solar companies, it’s possible even the worse case scenario for Daqo has already been priced in with shares as low as $7.00 recently.