European Austerity Means a Cloudier Forecast for LDK Solar
LDK Solar (LDK) and other solar plays like First Solar (FSLR), Suntech Power (STP) and Sunpower (SPWRA) have traditionally been dependent on demand driven by government subsidies. This has made these companies vulnerable to government policies, especially as countries like Germany, Spain and Italy have made budget cuts to their solar subsidies. LDK in particular has seen large swings in its stock over the past year and a half, which rose from $5.20 in July 2010 to a high of $14.55 in February 2011 before declining to around $6.61 at Thursday's close.
We have revised our estimates for LDK Solar based on recent developments and guidance from the company. We lowered our price estimate from $16.09 to $12.26, which is still meaningfully above the market price due to our constructive view of LDK Solar and the industry's long-term fundamentals.
Below we highlight the short-term factors that have weighed on the stock and the factors that shape our long-term thinking of the stock.
Recent Developments Concerning the Market
1. The revision of European solar subsidies in key markets
As a result of the financial crisis and the worsening debt situation in Europe, several large nations were forced to reevaluate the subsidies they extended to the solar industry. Earlier this year, the German government announced its plans to cut subsidies by 15% in 2011. More recently, the Italian government announced its plans to reduce feed-in tariffs.
The Italian government plans to progressively lower its subsidies to the solar industry. LDK depends on the Italian market due to its controlling stake in Solar Green Technology, whose revenues are highly dependent on growth opportunities in Europe.
In addition to the government cuts, demand has not matched the ramp up in supply of PV modules, so solar manufacturers like LDK Solar will need to reduce prices significantly to drive demand. According to a recent report by Bloomberg New Energy Finance, monocrystalline cell prices slumped 7.5% to $1.14 per watt in May from the previous month and multicrystalline cells were down almost 9% at $1.09 per watt.
2. Credit crunch impacting solar industry
The outlook for the solar industry has also dimmed as a result of the credit crunch. While credit conditions have improved since then, project financing has been a challenge as lenders view solar projects as risky due to the uncertain nature of the business and reliance on government support. Banks that are engaged in project financing are preferring to fund smaller projects, which has led to excess capacity in the PV space.
3. Solar companies lower guidance
On April 26, LDK lowered its first quarterly revenue guidance for revenues and shipments. Revenues are expected to range between $745 million and $755 million compared to its previous guidance of $800 million to $850 million. While part of this decline may be attributed to a delay in shipments to customers in Japan, the bulk of it is due to the uncertain environment in Italy regarding subsidies for the solar industry in the future.
A number of other solar players have also lowered guidance in the first quarter, among them Yingli Green Energy (YGE) and Trina Solar (TSL). Both companies said that declines in shipments were due to the uncertainty in Italy.
Long-term Fundamentals Remain Compelling
Despite these headwinds, we believe that governments will not abandon solar altogether, and that business and industry fundamentals justify a higher valuation.
1. Government subsidies expected to continue although at declining rates
Despite the short-term headwinds that the solar industry faces, the room for growth is almost unlimited. According to data collected by Eurostat, Spain's solar energy production as a percent of total electricity production amounted to only 2.13%. This is in comparison to Germany's 1.11% and 0.03% in the US. This clearly indicates the large potential in this space.
The Italian government still has an overall target of 23 gigawatts of cumulative installations scheduled for completion by the end of 2016. In addition, we expect the shortfall in European demand will be compensated by increased growth in solar installation in Asian and the Middle East as a result of increased demand for energy.
2. Demand for solar remains
Following the crisis at the Fukushima Daiichi nuclear power plant, the Japanese Prime Minister laid out a new energy plan seeking to increase the share of alternative energy to 20% of the total power supply by the early 2020s.
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He also aims to put solar panels on 10 million houses by 2030. China recently announced its latest five year plan to increase the country's solar power target to 10,000 MW by 2015 and 50,000 by 2020. This should help benefit local Chinese manufacturers like LDK Solar, JA Solar, Yingli Green Energy and others.
The outlook globally still remains murky for traditional energy sources, which has driven renewed interest in the alternative energy space. Factors such as geopolitical uncertainty in the Middle East have helped drive oil prices significantly higher in the earlier part of 2011.
In addition, many countries are reevaluating nuclear power after the crisis in Japan. The Italian government recently won a vote of confidence to shelve plans to build new nuclear power plants, and Germany also announced the temporary closure of its two oldest nuclear power stations and suspended plans to extend the life of its remaining plants.
3. Falling wafer prices will stimulate demand
The decline in prices as a result of excess solar capacity and the reduction in demand due to the removal of government subsidies has resulted in pricing pressures for solar modules.
This has been exacerbated by the fact that solar energy is still quite expensive compared to traditional forms of energy production. This supply and demand imbalance is eventually expected to result in a situation where prices will decline to a level such that solar energy becomes affordable without the need for subsidies. This point is often referred to as "grid parity."
See our full analysis for LDK Solar.
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