Market Pullback Signals Buying Opportunity for Certain Stocks

Jun 10, 2008
Author: SCP Editor

June 10, 2008 – Several companies that we think are attractive at higher prices have become cheaper in recent sessions, while the fundamentals have improved. We aren’t completely surprised that the stocks have pulled back, given that our outlook for the broader indices has and remains bearish. On the other hand, we see the pull back as a substantial opportunity to accumulate, keeping in perspective that our near term targets for the DJIA and Nasdaq are 12,000 and 2,200 respectively. Here are our top picks and representative opinions:

Solar Sector – the primary negative news in the sector really has to do with the fact that solar companies continue to face higher polysilicon prices, due to higher demand and supply shortages. The upside of this is that companies have been quicker to sign longer-term contracts as a means of locking in prices. The downside is that the higher raw materials prices has caused margin pressure to the silicon group. Our outlook on the sector remains absolutely bullish.

The key trends driving solar stocks persist:

 ·         Rising energy and oil prices

·         Pressure to reduce carbon footprint

·         Government legislated mandates to adopt alternative energies

We have written elsewhere that the current contribution of solar to the grid is nominal – less than 1% in the U.S. both in terms of production and consumption. Germany has been the leader in uptake, representing more than 50% of global solar consumption in 2007. But we are seeing uptake increasing in other areas throughout the EU and in certain states in the U.S. The key to more aggressive uptake for solar is the ability for solar to bring prices down closer to grid parity, which is about $0.10 per kilowatt hour. We still have a way to go here.

Nonetheless, the leaders in the solar industry are demonstrating remarkable growth in terms of sales and profitability that has resulted a busy IPO season last year for solar companies, and outperformance on Wall Street. Thomas Weisel recently released its monthly update for June commenting that since January, 2007, the midstream solar sector is up more than 150% as opposed to the Nasdaq, which was up 4.5% and the S&P which was negative.

Again, solar consumption and production remain nominal contributions to the grid, but with mandates coming from the government, energy agencies and increasing consumer demand, expect that the consumption and production contribution to global energy consumption to show dramatic increases on a relative basis in the coming years. After all, 40 minutes of sunlight is sufficient to power the globe for a year. We just have to get better at harnessing it – and we will.

So, in our opinion, the volatility that we are experiencing in the markets right now, which is largely attributable to circumstances that actually bode well for solar, should be seen as an opportunity to accumulate and build positions. In particular, we have been touting two companies here at the Small Cap Pulse:

LDK Solar (NYSE:LDK) – one of the clear leaders in the midstream solar space. We reintroduced it to our readers in April at the $31 level, and it has since run up to as high as $48. Now, it is back to the $37 level despite the fact that its fundamentals have never been better. The company released results for Q1 2008 on May 12:

·         Q1 revenue of $233.4 million, up 21.4% Q/Q and 218% Y/Y

·         Gross profit of $64.6 million, up 11.2% Q/Q and 127.5% Y/Y

·         Net income of $49.8 million, or $0.45 per share, up 130% Y/Y

·         Signed 6 long-term supply agreements for the Q

·         Total wafer shipments increase 27.6% to 119.2 MW in the

why is LDK getting pressured? As we intimated above, the company, as with the other solar companies, are facing higher polysilicon prices that are pressuring margins. For example, LDK’s gross profit margin for the Q1, 2008 was 27.7% compared with 30.1% in the Q4, 2007 and 38.7% Y/Y. One thing strikes us as certain – LDK continues to execute, and its guidance for 2008 supports this conclusion:

·         Revenue forecasted in the $1.08 billion to $1.18 billion range

·         Wafer shipments in the range of 560 MW to 580 MW

·         Gross margin in the range of 23% to 28% and

·         Annualized wafer production capacity to be 1.1 GW by the end of 2008 and 2.0 GW by the end of 2009

·         More than 90% of its 2008 required silicon is secured

Importantly, the company is forecasting a return to much stronger gross profit margins moving into 2009. It is going to be increasingly able to create and leverage economies of scale and cost reduction due to its increase in production/capacity. And it is bringing polysilicon production in-house, with installed manufacturing capacity of 7,000 MT by the end of 2008.

On May 12, we wrote that “we remain bullish on the stock, which is trading at $38.05….and an EV/sales multiple of about 7.89, and forward EV/sales (2008) of about 4.30x. At the current 7.89 multiple, we would project an EV of $7.5 billion, which would put the stock in a range well into the $60 level” and

On May 22, we wrote that for 2008, “we are forecasting $188 million in earnings, or about $1.77 per share, up from $524 million in revenue and $139 million in earnings, or $1.37 per share in 2007. We discounted our forecasted stock price using P/E and P/S methods by 30% based on the fact that we are forward-looking and due to margin pressure in 2008 and have arrived at a forecasted trading range by the end of 2008 of $57 to $64….keep in mind also that the company is sitting on a backlog of 1,078MW in 2009, 1,2221MW in 2010 and 7.151MW in the 2011-2018 period. We estimate that this collectively represents a backlog of $18.9 billion.  

We stand by that analysis, and are pounding the table on the stock at current levels. The company announced it is hosting an analyst day on July 11, and to be sure, it will have an impressive audience to make its case with. We would suggest taking advantage of the broader market weakness and pullback in LDK’s stock as an opportunity to do some more accumulating today.

Disclosure Note: SCP Editor is LONG LDK.  


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