Polysilicon Overcapacity And Policy Shifts Will Pressure Margins And Earnings For Years

Catalysts

About Daqo New Energy

Daqo New Energy is a China based manufacturer of high purity polysilicon used in solar photovoltaic applications.

What are the underlying business or industry changes driving this perspective?

• Rapid policy driven capacity rationalization through mandatory energy consumption standards may eliminate higher cost competitors faster than demand can absorb. This could potentially trigger a second investment wave of new low cost capacity that restores oversupply pressure and caps long term polysilicon selling prices, weighing on revenue growth.
• Daqo's aggressive ramp from roughly 40% utilization to above 50% and its willingness to raise output into a structurally oversupplied market risk locking in low price contracts during the recovery phase. This may limit future ASP upside and compress gross margins when input and power costs normalize.
• Expected consolidation frameworks and quota like mechanisms may initially support pricing, but they also encourage surviving producers to chase scale. This can increase nameplate capacity faster than domestic and global solar installations, which could re create 2 times overcapacity and pressure EBITDA and earnings through the cycle.
• Heavy reinvestment in digitalization, capacity upgrades and potential consolidation related contributions may consume a large portion of the company’s USD 2.21 billion cash and liquid assets. This could reduce financial flexibility just as profitability turns modestly positive and limit future return on equity and earnings per share.
• China’s plan to lift solar and wind capacity to around 3,600 gigawatts by 2035 drives very high near term expectations for polysilicon demand. However, if installations grow only at low single digit rates from current 220 to 280 gigawatt levels, Daqo could face a long period where realized prices and utilization stay below market forecasts, which may lead to structurally lower net margins and volatile earnings.

Assumptions

This narrative explores a more pessimistic perspective on Daqo New Energy compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Daqo New Energy's revenue will grow by 30.5% annually over the next 3 years.
• The bearish analysts are not forecasting that Daqo New Energy will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Daqo New Energy's profit margin will increase from -53.7% to the average US Semiconductor industry of 14.7% in 3 years.
• If Daqo New Energy's profit margin were to converge on the industry average, you could expect earnings to reach $208.7 million (and earnings per share of $3.02) by about December 2028, up from $-343.4 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $531.9 million in earnings, and the most bearish expecting $-130.9 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 7.1x on those 2028 earnings, up from -6.3x today. This future PE is lower than the current PE for the US Semiconductor industry at 37.3x.
• The bearish analysts expect the number of shares outstanding to grow by 0.73% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.39%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• China's 2035 environmental targets and commitment to expand wind and solar capacity to 3,600 gigawatts signal a sustained structural tailwind for solar PV demand, which could support higher polysilicon volumes and stabilize or grow Daqo New Energy's revenue over the long term.
• Government led anti low price initiatives, mandatory energy efficiency standards and industry consolidation efforts may force higher cost producers to exit, tightening effective supply, supporting polysilicon pricing and improving Daqo's gross margin and operating margin over time.
• Daqo's position as one of the lowest cost and highest quality polysilicon producers, combined with ongoing cost reductions to a record low cash cost of USD 4.54 per kilogram, could allow it to gain share as weaker competitors retrench, lifting its earnings and net margin through the cycle.
• The rebound in polysilicon prices, sharp increase in sales volumes, positive EBITDA of USD 45.8 million and a swing to adjusted net income of USD 3.7 million indicate that the company is already benefiting from the cyclical upturn. If this trend continues it could underpin a sustained recovery in earnings and support a higher share price.
• Daqo's very strong balance sheet with USD 2.21 billion in cash like assets and no bank loans provides strategic flexibility to invest in technology upgrades, digital transformation and potential consolidation opportunities, which could enhance long term competitiveness and drive higher revenue and earnings resilience.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Daqo New Energy is $15.6, which represents up to two standard deviations below the consensus price target of $31.31. This valuation is based on what can be assumed as the expectations of Daqo New Energy's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $39.0, and the most bearish reporting a price target of just $14.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $1.4 billion, earnings will come to $208.7 million, and it would be trading on a PE ratio of 7.1x, assuming you use a discount rate of 11.4%.
  
• Given the current share price of $32.06, the analyst price target of $15.6 is 105.5% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.