Strong balance sheet but headwinds remain.
• Capacity expansion plan delayed but will continue to despite industry-wide oversupply.
• Will continue buybacks using strong net cash position.
• Share price re-rating could be constrained by Xinjiang exposure and ASP pressure.
• Maintain HOLD with US$24 TP
What’s new?
We recently had an update with Daqo. Here are the main takeaways.
1. Oversupply in the polysilicon sector could persist throughout 2024, but Daqo will continue with its capacity expansion plan.
Daqo currently has c.205,000 MT of polysilicon production capacity as of Dec-2023. The company plans to add 100,000 MT (+49%) in Inner Mongolia to reach 305,000 MT total in 2024. Originally Daqo had planned to complete this expansion plan in 2023 but given market conditions (weak ASP) the company has slowed down the pace. Regarding the location of capacity expansion, Daqo prefers to stay in China at this stage. However, the company does not rule out opportunities in Saudi Arabia. For industry-wide oversupply, Daqo expects smaller polysilicon players to exit the market in the near future due to two main reasons. First, smaller players have higher production costs. Second, the increasing adoption of N-type module will require higher quality raw materials. Newer players are not yet able to produce high purity polysilicon at sufficient quantities.
Our view: Daqo’s all-in polysilicon production cost is around c.Rmb48/kg, which compares favorably against the ASP of c.Rmb60/kg. Thanks to its low cost the company is able to maintain a largely full utilization rate. Furthermore, from our channel check we understand that N-type product penetration is around c.35-40% of the market currently and is set to rise to 60-70% in 2024-25. Thanks to R&D efforts, Daqo has been able to produce N-type polysilicon which account for c.60% of its volume. The company is better positioned compared to smaller players thanks to its higher quality product which should see stronger demand throughout the P type to N type transition.
2. The Siemens process will continue to underpin Daqo’s production technology.
Daqo has put R&D resources into fluidized bed reactor (FBR) but decided to stay with the Siemens process. The main reason is that granular polysilicon produced via FBR has a much larger surface area compared to rod silicon produced via the Siemens process. Larger surface area could result in higher potential contamination which could be costly for midstream wafer customers. Thus, Daqo has no plan to develop FBR at the current stage.
Our view: We reckon it is too early to tell which polysilicon production technology will dominate at this stage. Currently Daqo and GCL Tech (which uses FBR) have comparable production costs of Rmb45-48/kg range, which will remain below the spot polysilicon ASP.
3. With a strong net cash position, Daqo plans to continue with its buyback program.
Daqo recognizes its shares trade at a deep discount to book value. The company is considering extending its US$700m share buyback program. As of Sep-2023 Daqo bought back 7.28m shares for US$301.7m (c.43% of the program) at average price of c.US$41.42/share. Another proposal Daqo is considering is to sell small portions of shares of its c.72%-owned A-share listed subsidiary Xinjiang Daqo (688303 CH). The sales proceeds could be used to repurchase the US listed DQ US shares. The company has yet to determine its dividend policy and wants to maintain flexibility between dividends and share buybacks.
Our view: Daqo’s valuation is exceptionally low as the share price trades below net cash. We estimate Daqo has net cash of >US$30/share and any effort to return cash to shareholders should be welcomed. In terms of privatization, we reckon the possibility to be quite remote. Maintaining the US listing has some advantages, namely flexibility in raising finance should the opportunity to expand outside of China arises.
Overall view: We like Daqo’s efforts to return cash to shareholders. However, there could be two main headwinds impeding the re-rating of the shares. First, the company has significant production facilities (130,000 MT) in Xinjiang which is a sensitive topic to investors. Second, polysilicon ASP has yet to show signs of rebounding. So, we recommend HOLD on the counter with TP of US$24. Our target price is pegged to target P/E of 5.5x on FY24F EPS, which is near the 5-year average.