August 13, 2009 – LDK Solar (NYSE:LDK) reported for Q2 yesterday, and the results were pressured by a $175.8 million write-down which drove operating margin to a negative 102.9% and a net loss to $216.9 million. We expected the write-down given the fact that at the Q1 call management said its poly inventory was priced at about $150/kg and poly prices were then trading at about $75/kg. After the write-down, its inventory is priced at $80/kg while poly prices are at about $60-65/kg, so there is still going to be some margin pressure here, but the write-down will at least get the business back in place to start showing some margin improvement going forward.
While we are long-term extremely bullish on LDK’s vertically integrated model and its ability to cope with pricing pressures based on sheer scale, the challenge is getting to that point without completely destroying the balance sheet and managing to do so without continuing to miss guidance. There is good reason to be concerned about these caveats.
In January, management did warn that it expects FY09 results to be impacted by lower ASPs and lower wafer shipment volumes. Its updated outlook for FY09 was:
· Revenue in a range of $2.3 billion to $2.5 billion
· Wafer shipments in a range of 1.57GW to 1.67GW
· Annualized wafer production capacity to be 2.3GW b the end of FY09
· Gross margin between 22% and 27%; and
· Production between 3,000MT and 5,000MT of poly
At mid-year, the company has posted:
· Revenue of $511.6 million
· Wafer shipments of 437.7MW
· Annualized wafer production capacity at about 1.5GW
· Gross margin ranging from 2% in Q1 to -90% in Q2; and
· Poly production of 125MT
Results as of the end of Q2 are nowhere close to where management guided back in January. Giving management the benefit of the doubt that Q1 was worse than anyone had expected it to be, management’s recalibrated guidance for Q2 back on July 24 was that it would post:
· Q2 revenues in a range of $225 to $235 million
· Wafer shipments between 230 and 240MW; and
· A write-down of $150 to $160 million
The results came closer, but still depress. Revenues came in at $228 million (the low side of guidance), wafer shipments came in at 231.7MW (the low side of guidance) and the write-down was about $16 million more than the high side of guidance.
Meanwhile with $1.8 billion in debt ($1.2 billion short-term), it looks like the company is going to have to hustle to restructure its balance sheet, casting further uncertainty on the business in the near term. And management hasn’t exactly demonstrated lately an ability to nail its guidance, so there is a general believability factor.
So our outlook for the stock in the near-term is that it will underperform its peers until it works some of these issues out and/or trades to low enough levels where the multiples are attractive enough to mitigate the near-term risk.
Yesterday, in after hours trading the stock traded down to $9.40 (about 1.9x book), and at that level, the stock is trading at about an 11% discount to its peers on a price/book basis. And it is trading at 0.72x sales on a trailing 12-month basis. At our current (and lowered) FY09 revenue estimates for LDK of $1.04 billion, at $9.40 the stock is trading at 1.02x sales.
Given the fact that quality of revenues has been so poor (negative margins), it is reasonable to put more weight on the price-to-book side of the equation in terms of valuing the stock, and, we think the stock could slip back to a 1 to 1.5x price-to-book range in the near-term (especially if the broader markets pull back the way we think they could and should), which would put the stock in a range of $5 to $7.50.
In this range, given the company’s still leading position in the wafer markets, and opportunity to achieve sheer economies of scale and cost efficiencies through vertically integrating poly production into the process, we think the stock is attractive.
We have also been using derivatives to strengthen our cost average in the stock – back on May 6, when the stock was trading at $10-$10.87 we sold September 15 calls on LDK, at $1.15 and this morning the calls are at $0.05 on the bid. Given that we like the stock in the $5 to $7.50 range, we will be looking at opportunities to sell puts into weakness as a way to own it at lower prices.
Important Disclosure: Todd Pitcher is Long LDK.