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I am generally a long term investor looking for macrotrends which I believe may play out over the course of several years. While I look at a lot of varying criteria in researching potential investments, I'm more aligned with the analytics involved with investing. Although it's not always a... More
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  • Is Jiangsu Shunda in trouble?

         Earlier this week, local newspaper in Yangzhou(China) revealed some rather interesting bit of news.  It was reported that since May 2010, Jiangsu Shunda was late on a 50 million rmb bank payment.  Why this bit of news might be significant to the industry is because it may affect one of the largest solar manufacturers in the world - Suntech(nyse:stp).

         Shunda, based in Jiangsu China, has many subsidiaries that largely serve the crystalline pv industry.  In particular they operate a small 1500(some reports indicate 2500) ton polysilicon plant and have ingot/wafer capacity of somewhere in the neighborhood of 300-400mw.  They have around 500m in assets with sales of around 370m in 2009.  Originally, Shunda had very big plans on being a major player in the global solar industry which included spending up to one billion scaling up their polysilicon plant.  The credit crisis of 2008 changed everything for most in the industry including Shunda.  A month before Lehman's collapse, Shunda tried to ipo on the NYSE in hopes of raising a billion to fund their plans.  But as the credit crisis unfolded, lack of project financing brought global solar demand to a near halt.  Many larger players scaled back expansion plans while many smaller solar companies simply went out of business.  Industry demand did not start to pick up for another couple quarters, but by this time the window for a grand ipo plan had already closed.  Shunda was on its own.

         In the past year, the solar industry has come roaring back after looking right into the mouth of the abyss.  So why did Shunda default on a small loan payment?  Perhaps that is easier explained by looking at larger sister companies to Shunda - LDK Solar(nyse:ldk) and Renesola(nyse:sol).  Both ldk and sol operate in the exact verticals as Shunda, wafer manufacturing.  Both also have polysilicon plants which are in the process of ramping production.  As the credit crisis caused price corrections in the value chain, upstream verticals were hit the hardest and the fastest.  Prices for polysilicon which were on a parabolic rise above 400/kg in 2008, collapsed very quickly below 100/kg to eventually settle at around 50-60/kg.  Wafer prices also collapsed just as quickly.  Wafer manufacturers who did not have high stockpiles of polysilicon could buy it very cheaply at spot market prices, and sell finished wafer goods at much lower prices for a profit.  Downstream verticals such as modules saw much slower price erosion because they were in higher demand; dropping module prices caused internal rate of returns for subsidized solar projects to soar.  As a result, the pricing disconnect among the value chain caused most wafer and newer polysilicon manufacturers into a very tough 2009.  Losses mounted for both ldk and sol, and their balance sheet became incredibly stretched.  However, both ldk and sol were able to raise new capital through secondaries on wall street - a source of capital Shunda did not have access to.

         In addition, almost half of Shunda's invested capital went into their polysilicon plant.  Because Shunda is a new entrant to the highly technical field of polysilicon production, initial production costs may be higher than for established manufacturers.  Many larger polysilicon producers who have years of experience can produce at under 30/kg costs.  However many reports out of China indicate that in most cases, initial costs for newer producers ranged 70-80/kg, with some production costs over 100/kg.  GCL Poly, the largest and most successful polysilicon producer in China, produced at 60-80/kg for their first year, and was only able to reduce it below 40/kg after nearly two years of production experience.  This wasn't a problem prior to the credit crisis because selling prices were 200, 300, even 400+ per kg, but when prices collapsed to 50-60/kg many smaller and newer producers could not produce for a profit.  Thus it is possible that while Shunda is not losing money in their polysilicon business, it may not be generating enough to sustain the large debt the company accrued establishing the plant.

         These are only possible explanations and there could be other reasons why Shunda missed a loan payment.  After they defaulted, it was reported that local banks stopped loaning new money to Shunda.  This is where speculation regarding stp comes into play.  In 2008, stp bought nearly a 16% stake in Shunda for 102m.  Stp also has prepayments made to Shunda totaling 55m ending 2009.  In other words, they have a fairly large vested interest in Shunda.  But perhaps more importantly, Shunda operates in two verticals which stp does not.  A combination of the two companies would result in stp becoming a fully integrated si-pv manufacturer.  stp's scale and resources would also allow them to ramp Shunda to a larger more efficient scale, resources Shunda doesn't have on its own.  Why would becoming fully integrated be important?  As selling prices for end modules continues to drop, gross profits for each vertical shrink and synergies of being fully integrated become more apparent.  In fact, stp has been criticized for being slow to integrate as many of their direct peers originally less integrated than stp have became more integrated over the past year.  There is also one last twist to this speculation.  Shunda is based in Yangzhou, and stp has built one of their manufacturing plants very close to them.  Stp has also committed larger investments in the city, making it increasingly hard for the local government to continually "support" Shunda especially after their default.

         Keep in mind that this is all speculation made by local city reporters, but they do indicate high sources within the Chinese solar industry.  Things may play out very differently but if this speculation becomes reality, it would have a dramatic impact on one of the largest players in the solar industry.



    Disclosure: Long ldk and sol. No position in stp.
    Jul 30 9:34 PM | Link | 3 Comments
  • A potential reversal of fortune for the Chinese markets

         The SSE just broke above its 50ema and also made a higher high from the recent downtrend which started in April after the government put out additional lending restrictions which targeted the real estate market.  A strong close would potentially mark a bottom because many traders in China are more technically oriented than here in the US where a lot of the institutional money is more concentrated in longer term fundamental investing.  Not surprisingly since it was in part the cause for the downturn, the recent bounce started when indications from the central government suggested they had stepped on the brakes long enough.

         It was in late 2008 that the SSE bottomed and started trending up after the credit crisis hit.  It was not until three months later did the US markets bottom.  From bottom to top, the SSE nearly doubled but has since given up 2/3s of those gains or roughly 1/3 of its value.  The start of the decline was almost exactly a year ago.

         But this is just technically speaking.  Fundamentally China did nothing more than slow modestly even during the depths of the global credit crisis. Many sectors of the Chinese economy were quite hard hit, but the shift towards domestic consumption kept the economy as a whole growing until the world economies slowly recovered.

         However despite this, many Chinese stocks got hard hit nonetheless. There are exceptions, but most smaller cap companies were among the hardest hit and suffered multiple compressing well into the single digit PEs. Larger caps held better with many moving sideways during the downtrend of the past year. Still, in most cases multiples are in the teens with many SOEs (state owned enterprises) sporting dividends above 3%.

         In summary, for those who always wanted to add direct China exposure to their portfolio, now might be a good time to start looking.  Since many of the larger and more established companies have already listed on the US exchanges, there's no need to look elsewhere.  In many cases, valuations are quite low relative to longer term potential growth rates.  There is also the added transparency required for US listing, because companies have to follow SEC guidelines.  Many stocks have been cheap for some time now, and many even got cheaper during the recent correction.  With the overall Chinese market showing more positive technical strength, both timing and valuations may be on the side of longs now.

         The same set of investing criteria apply, as usual.  It's best to look at more established companies with strong balance sheets and cash flows.  Look for industry leaders even if absolute valuations aren't as low as second and third tier competition.  For those who are more conservative, SOEs that have dividend yields above 3% might be a good option.  It's always good to get paid while you wait, especially when longer term macro trends are still positive.  Normally smaller cap companies should be lesser weighted simply because they tend to have less resources and competitive positioning.  However, it may not be a bad idea to have a basket of smaller companies who have shown past execution.  One good rule I go by is - the smaller the company, the smaller the percentage in your portfolio it should be.

    Jul 28 3:18 AM | Link | Comment!
  • A controversial company in a controversial sector
         Although I have written extensively on the solar sector in the past, this will be my first article on this medium. As such, I thought I should write about a company I have often criticized in the past, instead of the company I've almost exclusively argued as one of the best investments, for those who believe in the longer term merits of the solar industry. After all the trials of the credit crisis, tsl(Trina Solar) has already proven itself and emerged as a premier name in the solar sector. It's gone from misunderstood and black sheep of the sector, to one of the more recognized names, converting many skeptics along the way. Thus, it's just too easy to write about tsl now, and perhaps even boring as they continually execute far beyond what most expected. While I still believe tsl is the single best name to invest in for those who want solar exposure, I thought a more interesting debate would be about a name often mired in controversy in the past - ldk (LDK Solar).

         Ldk started out as a single vertical solar company - a wafer producer.  Essentially they purchase polysilicon, cast ingots, and saw thin wafers from it. These wafers are then turned into cells which are consequently assembled into modules by downstream verticals.  What made ldk a more interesting name was in late 2007, they engaged in a large polysilicon project - a very expensive and long lead time project with high risks for those new and inexperienced in producing polysilicon.  It seemed a good idea at the time as prices for polysilicon were on the rise from about $200/kg to ultimately cross above $400/kg before the credit crisis sent shockwaves across the industry and sent prices across all verticals crashing down.  Current polysilicon prices are around $50-60/kg today.

         Because this project drained over 1.5 billion in very important cash flow for over two years, ldk slowly accumulated a very high level of debt. Their balance sheet became further stressed by continued and aggressive expansion in their wafer business.  The situation became more serious after the credit crisis hit in late 2008, causing prices across all verticals to drop dramatically, with the prices for polysilicon taking the highest percentage hit - from over $400/kg to below $100/kg within weeks.  The pricing correction hit ldk harder than many peers within the industry because they had a high level of inventory prior to the credit crisis.  Besides large inventory charges that followed, ldk would then need several more quarters to slowly blend their remaining inventory to reflect market prices.  The result wasn't pretty.  After several quarters of large losses, it reached a point where ldk had less than 100m of cash left, while their debt climbed to nearly 2 billion.  Many including myself, wondered if they would make it.

         As it turned out, ldk's ceo Mr. Peng, had the connections to pull off a debt restructuring which involved in part selling a stake in their polysilicon plant.  This didn't solve their debt situation, but it bought enough time for ldk as their core business started to turn around.  As a result of the falling end pricing for solar modules, demand soared in markets with high levels of subsidies such as in Europe, namely Germany, due to the high level of returns solar generated.  Solar demand worldwide continue to surge this year, with many predicting over a 50% annual growth rate.  I apologize for the long boring history, but I thought it was important to describe the situation for those new to the solar sector.  It leads to where ldk is today. 

         The basic argument that most bulls might make is that ldk's core business, the wafer vertical, has finally reached a normalized level of profitability. Input costs have been blended down closer to current market prices, while end demand continued to remain incredibly strong, resulting in gross margin expansion.  Ldk's gross margins went from negative, to low under .10/watt levels in recent quarters, to what appears to be over .15/watt levels looking forward.  Combined with higher shipment levels, ldk starting in Q2 will be extremely profitable on a corporate level.  I don't want to make an argument based on earnings here, because that's not my bull thesis on ldk.  Needless to say, ldk is most likely trading at or under 10x 2010 earnings with its stock price around 6 dollars.  I may describe in more detail all the math involved later, but since this isn't my argument today, I won't do it here.  In general, most of ldk's peers aka other Chinese solar companies, are cheap, so being cheap relative to earnings isn't a special bull case as things stand today.

         What has changed in ldk's case, which is very different from other names, is the news we heard from the company about two months ago.  Instead of promises polysilicon production that were continually pushed back, ldk finally reported a meaningful level of polysilicon for the fourth quarter of last year.  This was encouraging, but nothing that screamed out attention because output was still low, resulting in fairly high fully loaded production costs.  About six weeks later, ldk reported first quarter earnings, which had even more encouraging metrics.  Not only had ldk successfully ramped their smaller polysilicon plant to high levels, but in just the first quarter of commercialization, the first stage of their larger plant ramped quite well.  Further news suggest that they reached near full utilization less than two quarters of operation, with accretive production costs.

         In other words, that 1.8 billion high risk project that yielded no returns while draining much needed liquidity for over two years, is finally paying off.  This isn't important to ldk on an earnings level, because fully loaded costs which includes a high level of depreciation, will not be low enough to make significant contributions to ldk's bottom line.  Why this is more significant is because their polysilicon plant will add to more improtant cash flows.  Ldk already spent the money for this project.  Ldk was already paying high levels of interest for the plant.  Now, whatever level of polysilicon ldk can produce from this plant, will be positive to cash flow equal to the difference between current market prices and the cash costs for their polysilicon production.  Based on my derived numbers from their reported metrics, I estimate ldk will generate 15-20 million in cash flow per metric ton of polysilicon produced.  This will result in up to 100m in additional cash flow for 2010, and potentially 200-300m in annual cash flow once the plant is fully ramped, assuming the same spread between cash costs of production and polysilicon market pricing.

         In my opinion, because of all the controversy regarding ldk's polysilicon plant in the past, from costs to delays, the market had all but written it off.  However, despite the initial delays which were not totally unexpected for any new entrant, ldk has successfully produced polysilicon, and ramped their production rather quickly.  This suggest the final ramping of their plant should go just as efficiently, given now that they have more experience.  Because ldk will essentially consume all the polysilicon they produce, they will generate additional cash flow equal to the different in their cash cost of production, and the market prices which they would otherwise have to pay for polysilicon.  Since about 90% of the polysilicon plant has already been paid for, the cash flow generated will be free cash flow after they put in the final capex to finish the entire project.  Ldk also already has a high wafer capacity, and their wafer business should generate enough operating cash flow, based on current metrics, to cover further expansion on an annual basis.

         Thus while ldk and peers may be trading at low earnings valuations if the business environment doesn't materially change from the guidance they have given, what sets ldk apart is their high installed fixed assets, namely their polysilicon plant. This will put ldk in a positive free cash flow position that alone may justify higher valuations.  In contrast, some other peers have expansion plans that cause them to be generally cash flow neutral or negative.  It is this cash flow situation, along with what should be a good earnings year, that the markets may not have properly reflected for ldk currently.

    Disclosure: Long tsl, solf, ldk, sol, and jaso
    Tags: LDK, TSL, solar, green, energy
    Jun 03 4:46 PM | Link | 4 Comments
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