Why LDK is One of the Best Stocks to Own in 2009

January 5, 2009 - LDK Solar (NYSE: LDK) closed at $13.12 on Wednesday, the last session of 2008, holding a market cap of $1.48 billion, about 1.06x trailing 12-month sales and 4.42x trailing 12-month earnings. We think this stock is remarkably cheap, and represents one of the best investment opportunities for growth oriented investors and it is the best one that we know of. Here is why.

* Strong revenue and income growth - Most recent quarter (Q3) reported revenues of $541.8 million, up 22.7% sequentially and 241.4% Y/Y. Net income for the quarter was $88.4 million, or $0.77 per share, compared to net income of $149.5 million, or $1.29 per share in the second quarter and an increase of 112% from the $41.6 million, or $0.37 per share reported for the same period last year. Note: the decline income to $88.4 million from $149.5 million in the prior quarter resulted from a one-time revaluation of $60 million, or $0.50 per share relating to the change of a prepaid forward contract.

* Strong performance and consistency - reported financial results on high end range of previous guidance in most recent quarter and again, raised its target for annualized production capacity for 2008 to 1.4GW, 2.3GW by the end of 2009 and 3.2GW by the end of 2010.

* Strong backlog - booked more than 14GW in wafer orders pus 6GW of wafer processing service orders. To put this in perspective, LDK's sales in Q3 on 206.3MW in wafers were about $541 million. As of October 30, 2008, LDK had secured contracts totalling 1.8GW for 2009, which is more than 100% of its planned output for the year. Its forecasted revenues of $3 billion in 2009 are already locked in.

* Solid balance sheet, cash position and access to capital - About $406 million in cash, or $3.06 per share, and a credit facility of about $430 million.

Concerns:

* ASP erosion and gross margins - as with other solar firms, LDK has had to deal with issues of module oversupply which are pushing down ASPs and creating margin pressure.In the most recent quarter, it reported declines in gross margin to 22.7% from 25.4% in the prior quarter (Q2). However, management attributed this to higher silicon sourcing costs and indicated that it actually increased its selling prices. Gross margins in the Q4 are expected to come in between 18% to 21%, which would be another decline, which would, in our opinion, reflect the industry conditions more accurately.

LDK 's ASP per watt in Q3 were $2.48, management is guiding in Q4 that they will be $2.20 and in 2009 they will likely come in about 10% lower than at present to about $2.00.

Management believes that as it begins to become more vertically integrated, moving its polysilicon production in-house, it will be able to buffer, and even improve margins. We should begin seeing this take effect in the second half of 2009. Managment has indicated that gross margins will bottom in Q1, 2009 and begin strengthening into Q2.

It is also important to note that a significant amount of LDK 's margin pressure has been a consequence of a weaker euro. But the euro began strengthening against the dollar in the second half of December, and our outlook for the euro is bullish relative to the dollar, in 2009.

* Polysilicon plant and production  - There have been concerns about LDK 's buildout of its poly plant, associated costs and access to capital in a tight credit market. In terms of progess getting its poly manufacturing facility on track, management said it expects to produce between 5,000MT and 7,000MT in 2009. This has been one of the few areas in terms of LDK's performance which haven't been on schedule, so its adjusted polysilicon output in 2008 is in a range of 15MT to 25MT. 

* Long-term Take-or-Pay contracts - while these are a strength, in our opinion, of LDK 's business, providing long-term visibility on revenue, with pre-payments and fixed prices, there is some skepticism amongst analysts following the company that there could be cases where a customer experiencing financial difficulty comes to LDK providing little notice that it can't honor the contract any more, and whether LDK has enough incremental demand to make up for this volume. Management has addressed this concern directly and says the risk here is low, in light of the quality of its customers and prepayments already made.

Our Take

We think that the risks addressed by the concerns noted above have more than been priced into the stock price.  Keep in mind that in September, 2008, LDK raised $192 million at $41.75 per ADS, about 218% higher than Wednesday's closing price. We are forecasting $1.77 billion in revenue and $371 million in net income for FY2008 and $3 billion, with $600 million in net income for 2009. This equates to 239% Y/Y projected revenue growth for FY2008 over FY2007, and 69% Y/Y projected revenue growth for FY2009 over FY2008. And on an income growth basis, this equates to 158% Y/Y projected income growth for FY2008 over FY 2007 and 61% Y/Y projected income growth for FY2009 over 2008.

We believe that our forecast estimates are extremely conservative, given the fact that we have three of the four quarters for FY2008 under our belt at this point, and LDK's contracts are long-term take-or-pay with prepayments, not to mention management's track record of hitting the high range of its guidance. That being said, we think that a 1.5x P/S multiple on FY2008 sales and an 8x P/E multiple on FY2008 income are easily defensible. These multiples would yield an implied $23 to $26 stock trading range, an increase of 75% to 98% respectively.

To further emphasize how conservative we think our estimates and price targets are, consider the fact that management has already guided that it is oversold on capacity for FY2009, with more long-term take-or-pay contracts and prepayments. Now, assuming our target stock trading range of $23 to 26. At those levels, the stock would only be trading 0.89x FY2009 sales and 4.96x FY2009 income.

The upside for LDK's stock is extremely compelling, we think. At 1.5x our forecasted FY2009 sales and 8x our forecasted FY2009 income, the stock trading range would be $39 to $42, a 197% to 220% increase from current levels - and keep in mind that LDK raised $192 million in a follow-on offering back in September, 2008 at $41.75 per ADS, so there is a market for this stock at significantly higher levels.

IMPORTANT DISCLOSURE NOTE: SCPEditor is LONG LDK. The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance.