Summary
Daqo New Energy Corp. (NYSE: DQ) is a leading manufacturer of high-purity polysilicon, a vital component in solar photovoltaic (PV) cell manufacturing. The company has experienced over a 55% stock price decline over the last year, primarily attributed to the oversupplied environment and subsequent pressure on Chinese polysilicon prices. Despite this, we believe the company is currently undervalued, given the growth prospects of its optimization of operations and strategic initiatives to manufacture its own silicon metal and enter the semiconductor-grade polysilicon market. Moreover, the company is considered a net-net investment, with a net asset value (NAV) bigger than its market capitalization.
Bear Case
Amid a supply gut, Chinese polysilicon prices started to decline since the beginning of 2023, adding to a year-on-year loss of over 50%. This drastically affected Daqo New Energy’s revenue as it had to adapt to lower prices throughout the year. For instance, polysilicon average selling price (ASP) was $7.68/kg in Q3 2023, compared to $12.33/kg in Q2 2023, and revenue was $484.8 million in Q3 2023, compared to $636.7 million in Q2 2023. [Pg. 1]
If Chinese polysilicon prices continue to decline, Daqo’s revenue could fall even more, posing an inherent risk to the investment. Nevertheless, there’s also a cyclical opportunity to buy near the bottom of the market as it recovers. As Peter Lynch remarks in his book Beating the Street: “I’m willing to invest in cyclicals at their nadir. Just when it seems that things can’t get any worse with these companies, things begin to get better. The comeback of a depressed cyclical with a strong balance sheet is inevitable.”
Part I: Strategic Optimizations and Projected Growth in Polysilicon Production
Daqo has substantially optimized its operations throughout the year, which would’ve translated into revenue growth in a more favorable economic environment. In particular, polysilicon production volume was 57,664 MT in Q3 2023, compared to 45,306 MT in Q2 2023, polysilicon sales volume was 63,263 MT in Q3 2023, compared to 51,550 MT in Q2 2023, polysilicon average total production cost was $6.52/kg in Q3 2023, compared to $6.92/kg in Q2 2023, and polysilicon average cash cost was $5.67/kg in Q3 2023, compared to $6.05/kg in Q2 2023. [Pg. 1]
These improvements are expected to continue during Q4 2023, adding to the overall efficiency of the production process, and achieving an expected full year production volume of approximately 196,000 MT to 199,000 MT, representing an increase of 46% to 49% compared to 2022. [Pg. 3] Production growth is especially relevant to further enhance Daqo’s economies of scale and keep it competitive as solar PV technology keeps evolving.
Part II: Polysilicon and Silicon Metal Project to Integrate Upstream Supply
Daqo’s announcement of the investment agreement for the establishment of a polysilicon and silicon metal project through its subsidiary Xinjiang Daqo signifies a strategic move to integrate upstream supply in the solar PV industry. The project, located in Shihezi, China, spans two phases, with the first phase involving significant production capacities of polysilicon, silicon metal, and silicon seed rods, requiring an investment of approximately RMB 7.5 billion. The second phase mirrors the first in terms of scale and investment. Once completed, the project is expected to receive green electricity and renewable energy green power certificates.
CEO Xiang Xu emphasized the strategic importance of the silicon metal project in achieving sustainable growth. The integration of the upstream supply chain aims to enhance Daqo’s competitive advantages in cost and quality, mitigate raw material price fluctuations, and ensure supply chain due diligence and traceability. With both project phases completed, the company anticipates self-sufficiency in producing all required silicon metal raw materials.
Part III: Net-Net Investment and Share Repurchase Program
Daqo’s robust financial position, as of September 30, 2023, underscores a compelling net-net investment opportunity. With current assets of $3,839,108,000 and total liabilities of $948,050,000, Daqo boasts a substantial NAV of $2,891,058,000. [Pg. 10] This positive difference between current assets and total liabilities goes to show of Daqo’s strong financial position. What makes this even more noteworthy is that the calculated NAV surpasses the company’s market capitalization of approximately $1.3 billion, which reveals a significant margin of safety for investors.
Moreover, management is putting its current assets to good use by executing a robust share repurchase program. By the end of 2023 Daqo successfully repurchased 14.55 million American Depositary Shares (ADSs) at an average price of $33.71 per ADS. The impact on the company’s capital structure is notable, with the total number of ordinary shares outstanding reduced from 391.0 million at the end of 2022 to approximately 328.8 million by the end of 2023, benefiting investors by substantially increasing their ownership in the company.
Fundamentals
Despite weak results during 2023, the company has achieved substantial growth throughout the years, with especially strong post-pandemic results. It generated revenues of $675.6 million, $1,678.8 million and $4,608.4 million in 2020, 2021 and 2022, respectively, and it achieved net profit of $129.2 million, $748.9 million and $1,819.8 million in 2020, 2021 and 2022, respectively. [Pg. 53]
The company also has solid free cash flow generating capabilities, with net cash inflow from operating activities in the first three quarters of 2023 amounting to $1.5 billion, with more than $711 million in the third quarter. [Pg. 3] And it has a reasonable level of liquidity with a current ratio of 4.7, according to GuruFocus. In essence, we consider the company has solid growth and a healthy balance sheet.
Despite this, the company trades at a P/S multiple of 0.55x, compared to its 10 year average of 1.29x, according to GuruFocus. This suggests a potential upside of 135% if it were to trade in line with its 10 year average. The decision to use the P/S ratio as a valuation tool is based on its effectiveness for evaluating cyclical businesses where the P/E ratio works poorly. It works the best when comparing the current valuation with the historical valuation because over time, a company’s profit margin tends to revert to the mean.
Catalyst
Increased revenue based on Daqo’s optimization of operations, strategic initiatives, and Chinese polysilicon prices stabilizing during 2024.
Disclaimer: This report represents our opinion and is not financial advice.
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