Not surprisingly and inline with recent generally negative news flow from direct Chinese solar peers, LDK Solar (LDK) announced a revision on its prior Q4 2011 quarterly earnings guidance. While not a warning per say since the company's new estimates are within the ranges outlined previously, LDK did lower expectation towards the lower band of its prior forecast. More significantly, the company also announced a number of expected charges that may result in another large quarterly loss.
LDK Solar now expects fourth quarter revenues to be between $440-450m which is at the bottom band of its original $440-520m guidance. Silicon wafer shipments of 215-220MW are also expected to fall in the lower half of its prior 200-270MW estimate. On the positive side, fourth quarter module shipments of 250-260MW are at the high end of its prior 180-270MW guidance. LDK's revision once again highlights a point discussed in a prior LDK review - the company needed to further integrate downstream in order to preserve its market share as its upstream business became increasingly more competitive and commoditized. With few exceptions, nearly all single vertical silicon wafer manufacturers are unprofitable at the market's current pricing levels.
A potential positive in LDK's announcement is that the company's module segment is likely to be its only profitable business. With further declines in upstream polysilicon and silicon wafer average selling prices("asp") in Q4 towards ranges around $30/kg and $0.35/watt respectively from $50/kg and $0.55/watt respectively, my prior estimates assumed no gross margin for these individual verticals. In contrast, whatever gross profit LDK may post in the fourth quarter would likely come from its module sales.
As a result and assuming module asp assumptions remained constant with prior expectations, LDK's recent revision may incrementally increase the quarterly gross profit assumption from my prior estimates. LDK did not update pricing nor gross margin expectations. Given the generally negative pricing environment the industry faced last year, conservative expectations should be assumed. In general as similarly structured direct peer Renesola (SOL) showed in its already announced Q4 earnings, LDK Solar may be hard pressed to maintain positive gross margin in the fourth quarter even exclusive of any charges.
While my prior estimate on LDK's operating results may not change materially given the company's update, a number of charges will further push US GAAP numbers deeper into the red. My third quarter review for LDK cautioned potential charges may be taken as companies tend to close out the year with a clean book. LDK now expects charges including an inventory provision, impairment of purchase commitments, accounts receivable provision, and fixed asset write downs for its fourth quarter. Although the company did not specify the magnitude for these charges, investors should expect the worse. US listed direct peer Yingli Green Energy (YGE) took over $573m in non-cash charges in the fourth quarter while Suntech Power (STP) retroactively applied $483m of non-cash write downs to its third quarter results. While these examples may represent extreme ranges, it illustrates the degree of potential charges companies may take in order to realign corporate balance sheets to reflect the industry's new operating environment.
Looking forward into 2012, LDK Solar gave an encouraging preliminary estimate which reflects further expansion of its downstream initiatives. While this guidance should only be viewed with a gain of salt especially after numerous downward revisions resulted throughout 2011 for many solar companies, LDK's projection offer a directional view where the company is heading. LDK estimates 2012 module shipments to range 1.0-1.3GW, or potentially double the 0.65GW shipment level in 2011. In addition, the company's downstream systems division appears to be accelerating with a project pipeline of 400-600MW to be constructed through this year of which 270-360MW is expected to be recognized as revenue. Overall, LDK estimates 2012 total revenues to range between $2.0-2.7 billion.
Although LDK Solar did not provide any gross margin guidance for 2012, the ranges provided in its guidance suggest a US GAAP loss for this calendar year. Assuming the current stressed environment for the solar industry persists for the rest of this year reflecting continued consolidation as the lowest cost producers continually operate at unsustainable non-reinvestment dynamics for as long as required to completely shake out less competitively positioned peers, LDK may only generate 10-15% consolidated annual gross margin. With an annual corporate expense run rate of approximately $400m, the company could lose anywhere from $200m to potentially breaking even at best under the ranges provided in its 2012 forecast.
On an operating cash level, the situation isn't as dire as potential US GAAP losses may suggest. Nearly all charges solar companies have taken recently have been non-cash in nature and generally reflect reevaluations of balance sheet items. Although LDK will likely write down a portion of its inventory and accounts receivable in the fourth quarter, the company had roughly $1.5 billion of these assets at the end of its third quarter which it could slowly draw down and generate cash flow moving forward. For example, Suntech reported a positive operating cash flow of $240m as similar assets were drawn down in its fourth quarter. Most peers have taken similar steps as companies look to tighten corporate belts in order to preserve or generate cash during the industry's ongoing consolidation cycle.
More importantly, LDK could still remain operating cash flow positive despite large US GAAP losses due to the company's high level of depreciation expenses. LDK reported about $75m in depreciation in the third quarter of 2011 and this amount should head towards $90m once its polysilicon plant is fully utilized. This represents roughly $360m in annual depreciation in large part due to the high fixed costs of its polysilicon plant. Assuming other balance sheet items remained relatively constant and capital expenditure was kept at a minimal, LDK could still operate at a positive cash flow level even if $200m or even $300m US GAAP losses were reported. This is one aspect many investors may fail to realize when evaluating the company's ongoing corporate sustainability.
In the longer term, industry pricing levels should eventually revert to sustainable levels which warrant reinvestment. It should be clear that sector demand exists and has been extremely elastic to pricing. Global demand has more than quadrupled from slightly under 6GW in 2008 when solar module asps averaged $4.00/watt to over 27GW in 2011 when the industry's top suppliers STP and YGE reported average annual asps of approximately $1.40/watt. Module asps will likely average less than 1.00/watt in 2012 representing further asp declines of around 30-35%, a view recently shared by a leading industry research firm Solarbuzz.
In contrast, the supply side has been distorted in the past year due to high volume inventory liquidations as uncompetitive companies have been forced to curtail or shut operations completely. Once industry consolidation has been mostly resolved, pricing should stabilize and revert to more normalized levels. Where hundreds of manufacturers once supplied the market, perhaps only a dozen or two extremely large scale, highly integrated, and cost effective producers will remain. Despite potentially large legacy charges the company may record, LDK Solar remains extremely well positioned to grow its market share while maintaining sufficient operating cash flow until industry pricing dynamics normalize and allow corporate profitability to return to the sector's most competitive companies.
Additional disclosure: No position in SOL, STP.