We are not fans of the solar companies. Despite receiving billions of dollars in direct and indirect subsidies, these companies continue to burn through cash worse than Frankie "the Flame" Fraine. Whether an investor purchases shares of solar companies such as First Solar (FSLR), JA Solar (JASO), Trina Solar (TSL) or LDK Solar (LDK), or whether investing in solar ETFs like Guggenheim Solar (TAN) or Market Vectors Solar Energy (KWT), investing in solar has been anything but sunny for investors. We previously analyzed JASO's $100M buyback and recommended that investors take advantage of it in order to salvage their remaining investment.
As lousy as the solar industry's business model is, manufacturing solar wafers is the lowest end in the industry food chain. Unfortunately, that spells bad news for LDK Solar, which originally focused exclusively on solar wafer manufacturing. We noticed that LDK has diversified its operations and is now involved in solar cell and module production. However, the majority of its shipments by megawatts are solar wafers.
We think that long-suffering investors of LDK Solar should sell now in order to salvage something from their investment in this company. We have noted that the company has $5.87 per share of gross cash and bank deposits on its balance sheet, representing a 68% price discount to liquid assets. As followers of the Graham-Buffett value discipline of investing, we would certainly take note of such a company in order to perform further research, analysis and evaluation on it. We would also be pleased that the company has a book value of $3.25, which means that the company is trading at a discount to book value of 42.4%. We believe Ben Graham would not only give his blessing to such a company, he would probably put a portion of his own money in it.
However, the Buffett side of us would certainly not buy this company, even though it meets Ben Graham's margin of safety requirements. We are interested in companies that not only trade at a margin of safety, but have the potential to grow its free cash flows. We haven't seen the solar company generate positive free cash flows from operating the solar business, nor do we expect it to ever generate positive free cash flows, even with the aid of government subsidies. The reason why we believe that LDK shareholders should simply cash out and salvage some value from this Grahamian-Smoldering Cigarette Butt is because of the following reasons:
- LDK's primary source of cash inflows since its formation has been $3.96B in net financing cash flows. LDK received $853M of net cash flows from common stock issuance net of share repurchases and dividends and $3.1B from net debt and preferred stock issuance. We expect our portfolio companies to generate its cash inflows from free cash flows from business operations.
- LDK has never generated positive free cash flows in any year. In 2010 it came close by incurring "only" $290M in free cash flow deficits.
- Like other solar companies, LDK's ability to generate revenues is heavily dependent on government subsidies, which have been cut back in the last year and are expected to continue to decline.
- Demand for the industry's products has not only stopped growing, but has shown rapid declines in the last year.
- Chinese solar companies are facing parity tariffs on exports to the U.S.
- LDK has missed its revenue and profit targets by a wide margin in the last four quarters, including this one.
We don't know what was worse, LDK's recent disasterpiece earnings release or its pathetic forecast for Q2 results. LDK reported $200M in revenue for Q1, which represented a 52% decline from the linked quarter (Q4 2011) and a 74% decline from Q1 levels. At least the company's loss declined to "only" $185M. We're not sure if LDK operations naturally incur a negative gross margin (cost of goods sold exceed revenues) or if they had to work on incurring negative gross margins. Either way it worked out well, because LDK has had a negative gross margin in 2009 and 2011, not to mention a negative 65.5% gross margin for Q1 2012. Other lowlights from the quarter include the following:
- Despite assuming $70M in net new debt during the quarter, the company's liquidity position declined by $59M.
- LDK Solar may have shipped 30% more megawatts of modules versus Q1 2011 levels; however it shipped 74% less megawatts of wafers versus Q1 2011 levels.
- Polysilicon production declined by 23% versus last year's levels.
In conclusion, we believe that if one is looking for a high-quality growth company or a deep value potential turnaround to invest in, we don't recommend investing in LDK. We believe that LDK is an overhyped, overrated, underachieving broken-growth stock that is dependent on rent-seeking activities based on the fad of "green energy". If "green energy" was economical then it wouldn't need government subsidies nor would "green energy" require government bureaucrats and technocrats forcing utilities to buy it and to pay inflated prices for it relative to market prices for reliable energy sources. We believe that if you want to build a $2.5B solar company, you need to start with $4B in seed capital and hope that management doesn't blow it all. Here are more reasons based on LDK's not-so-sunny outlook as to why we recommend investors sell their LDK shares and recommend aggressive investors short LDK shares:
- LDK is forecasting 300-350 megawatts of wafer shipments for Q2 2012, which is 17%-33% less than Q2 2011.
- Polysilicon production is expected to see a severe 80% decline relative to the comparable quarter in 2011.
- Cell is expected to be 80-100 megawatts, which represents a decline of 19-35% versus last year's Q2 levels.
- Cell and Module shipment increase of 75%-125% will not be enough to offset the declines in wafer shipments, cell production and polysilicon production, especially due to the lower market prices realized for solar modules.
Additional disclosure: Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this report. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.