Daqo New Energy: At A Pivotal Buying Moment

Summary

• Daqo New Energy's latest earnings report reveals a concerning trend: the growth of its polysilicon prices has slowed further.
• The projected surge in production for 2023 may spell trouble, as it could cause price levels to plummet even further.
• While management exudes confidence in its profitability, the critical question is whether DQ can ramp up production fast enough to mitigate the pricing downturn.
• The hype surrounding DQ stock has subsided, presenting a prime opportunity for investors to buy and add more exposure.
• I do much more than just articles at Ultimate Growth Investing: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

Anatoly Morozov

Daqo New Energy Corp. (NYSE:DQ) released its FQ4'22 earnings report on February 28. It demonstrated that the growth in its polysilicon average selling prices or ASPs has continued to normalize, justifying the steep pullback from its highs in August 2022.

Despite that, we updated investors in our early January article that the pullback could reach a bottom, urging investors that it's "time to be greedy."

DQ has outperformed the S&P 500 (SPX) (SPY) since then, up nearly 11%, relative to the SPX's 3.8% uptick, despite the recent pullback in Chinese equity ADRs. Moreover, it was up by almost 33% from its January lows through its February highs, as savvy investors bought the pessimistic lows in January.

Daqo polysilicon ASPs change % (Company filings)

Despite the moderation in its ASPs growth through FQ4, the resilience of its ability to sustain its price leadership was highly remarkable.

As seen above, Daqo New Energy posted an ASP of $37.3 in FQ4, up 10.4% YoY, as growth normalized. It also represented a 2.7% QoQ increase, despite the downstream inventory adjustment in CQ4'22, worsened by a "temporary seasonal slowdown."

However, DQ stressed that its utilization has improved in FQ1'23, as customers reacted to lower prices to bolster demand.

Despite that, recent price trends and management commentary suggested that the price normalization might not be over in 2023, even though DQ is still expected to maintain its price leadership.

Accordingly, downstream customers are still watching from the sidelines, likely anticipating prices to fall further as Daqo and its peers ramp production.

CEO Longgen Zhang also highlighted that prices could fall from RMB220 in Q1 to between RMB100 to RMB120 by Q4. However, the company remains confident of its cost structure, emphasizing that "[our] polysilicon is very profitable and will continue to make money."

With that in mind, we believe investors will likely focus on its 5A and 5B expansion phases, which will be critical to lifting its average production volume to mitigate the potential steep fall in prices.

Management updated that Phase 5A of its Inner Mongolian expansion (+100K MT capacity) has proceeded "smoothly." Daqo New Energy anticipates the project to be completed by June 2023, accretive toward its 2023 production guidance.

Accordingly, management guided an FY23 production outlook of 192.5K MT at the midpoint, indicating a YoY increase of 44%. Also, it's on track for its Phase 5B expansion plan, which will add another 100K MT capacity, expected to be completed by "the end of 2023."

As such, we believe the production ramp for Daqo New Energy must be closely watched by investors, even though the secular tailwinds for the solar energy industry remain robust.

Despite that, fears over a potential restriction of solar wafers export from China could potentially scupper the expansion plans of the solar supply chain in China.

A recent DIGITIMES report highlighted such a possibility as China reacts to protect against solar wafer technological transfers. It stressed:

China's restrictions on tech exports for solar wafers are designed to cement its leadership in the solar energy market, hobble the self-production capability of competing countries, and create more cooperation values for its partners in the Belt and Road Initiative. - DIGITIMES

The topic was also discussed between an analyst and management at its earnings conference. However, the company did not disclose any concrete plans to establish ex-China production facilities, even though Zhang accentuated that "the company will do a study if any opportunities arise."

Given the heightened geopolitical rivalry between the US, its allies, and China, we believe investors need to apply an appropriate "geopolitical discount" on such headwinds.

Chinese President Xi Jinping has also planned to consolidate more power within the party as he rolls out "deepening structural reforms" of China's state apparatus. Therefore, it appears to be shifting more power to Xi's party leadership and "further [eroding] boundaries between the party and government agencies."

As such, investors should always consider the geopolitical risk of investing in Chinese companies as Xi strengthens his control.

DQ price chart (weekly) (TradingView)

DQ appears to be consolidating constructively, with the lows in January well-supported.

Despite that, it must robustly hold the levels above the 200-week moving average or MA (purple line) before an upward move to re-test November highs seems possible.

With DQ's momentum potentially near the oversold zone, we parsed that another entry opportunity for investors to buy the recent pullback is constructive.

Rating: Buy (Reiterated).

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[buy_the_dips]

BABA is cheap! Tencent is cheap! DAQO is cheap!! Your returns will be cheap!!! Its cheapness all the way down!!!

[daydreamer]

If they never pay a dividend, what is it worth?

[kukukki]

@daydreamer exactly

The pivotal moment was not so pivotal after all. Dividends however would be such moment.

[typecheck]

@kukukki The stock is a joke. The company doesn't pay dividend but does the dubious buyback instead, which is completely meaningless if the stock were to be delisted.

[HerrSchulle]

@typecheck HK listing or dividend…

[Padd1]

Looking at DAQO's valuations, it looks like a total loss in the near future is more likely than unlikely. What do you think? What is the biggest risk and how likely is it?

[Pierre Rossouw]

Not much useful investment information here, mostly political views.

[jadboustani]

you should mention the book value, the stock is quite cheap!

[JR Research]

@jadboustani The market already knows.

[Friso Alenus]

Banning exports from China??? So where would countries get their solar panels? 80-90% polysilicon is made in China. Solar wafers 97% out of China :) Why is polysilicon price growth important?? Is 80% EBITDA margins not enough? Long term stabilised polysilicon prices are better so that solar panels are affordable. Nothing said about valuation, weird we give any rating without considering price. Clueless...

[typecheck]

@Friso Alenus Solar panels are the tea of the 19th century. The only choice for America is to start an opium war of the 21st century.

[JR Research]

@Friso Alenus
1. Not the first time we cover DQ. Valuation has already been discussed in our previous article, there's no need to rehash, with the article linked.

2. The market is not dumb. The market knows the cyclicality and commoditized nature of the polysilicon business.

3. Price action is forward-looking, because the market is forward-looking. Which is why it had already anticipated the slowdown, despite cheap valuations. Consider that it fell more than 50% from its August highs to its January lows. The market priced in the slowdown in August, even as ASPs growth was strong. Market looks forward all the time. Which is what we cautioned in August: seekingalpha.com/...

4. Don't be clueless. There's always something to learn for everyone. We are all learning.

[kukukki]

@JR Research
2. The market is not dumb. The market knows the cyclicality and commoditized nature of the polysilicon business.

For the past 18 months there is no cyclicality in DQ EPS so the market gotta be dumb.

DQ EPS did not change so the 50% drop was market's mistake? I am not really sure what market participants expected that DQ earning will drop. What I have been trying to point out for over a year in my comments is that DQ stock movements have absolutely nothing to do with financials. Even if their EPS drop in half (and nobody who knows DQ expected that for the past 18 months) DQ's PE would still be 4, grossly undervalued solely by financial standards. It was known already 18 months ago DQ earnings will be massive, because poly pricing is not secret and DQ's capacity running at max is known. Yet for 18 months the stock is grossly undervalued. So not sure why would now be some pivotal moment it all changes. Financially nothing will change at least not this year so if anything changes it will be non-financial matter.

[typecheck]

I wish they pay dividend instead of buying back shares.
I do understand why they do buy back since it is a convenient way to pay their executives in dollars.

[ANILB1]

Company has more cash by share than it's share price, cheap!

[Labybamapa]

@ANILB1 True and yet it's important what are they going to do with that cash ;)

[typecheck]

@Labybamapa The cash for is for constructing the second plant in Inner Mongolia. The share price should be 5X as much if DQ pays dividend instead of doing buybacks.

[Labybamapa]

@typecheck still patiently waiting for something to happen with really low avg. price. According to all my DCF analysis, PE, EV/EBIT analysis this should be really at least 3-4x from current price. Will wait a bit more.

[eddieclarkJr]

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