LDK Solar’s Upside & Downside Scenarios to $12 Valuation

LDK Solar (NYSE:LDK) derives most of its value from its solar modules & systems and China wafers businesses that account for 40% and 23%, respectively of the $12 Trefis price estimate for the company’s stock. The solar modules & system business sells photovoltaic (PV) modules to resellers, distributors and system integrators, and also provides engineering, procurement & construction (EPC) and wafer processing services. LDK competes with other solar energy players like First Solar (NASDAQ:FSLR), Suntech Power (NYSE:STP) and Sunpower (NASDAQ:SPWRA) & here we look at the some upside and downside scenarios to our estimates.

Here, we highlight 4 of the most important drivers for LDK’s stock and the upside/downside potential.

1. PV Modules, Systems and Other Businesses Revenue: The modules and systems business generated just under a billion dollars in revenue for LDK in 2010.

2. PV Modules, Systems and Other Businesses Gross Margin: The modules and systems business saw margins of 22.2% in 2010.

3. Average Selling Price of Wafers: LDK generated $0.89 for every watt of solar wafers it sold in 2010.

4. Wafers Sold in China: Solar wafers sales in mainland China for LDK was 588 megawatt (MW) in 2010.

48% Upside Scenario: $18 Trefis Price Estimate for LDK Solar

1. Modules & Systems business grows faster (+13%):

LDK primarily specializes in the solar wafer manufacturing business. These wafers are subsequently used by solar module manufacturers to make PV modules. But LDK has been focusing on vertical integration and has significantly grown its modules and systems business in recent years.

If the company continues to grow this business faster than what we currently forecast and generates $3 billion from it then the Trefis price estimate will see a 13% upside.

2. Modules & Systems margins decline slowly (+9%):

We expect LDK’s modules & systems business margins to reduce to about 18% by the end of our forecast period. LDK’s vertical integration strategy, and ability to source silicon cheaper than its peers by recycling it has helped it keep margins considerably high. While declining module selling prices will drive down margins, if it can continues to improve its operational and cost efficiency, margins will decline slower than expected and will remain above 20% over the same period. This represents a 9% upside to the Trefis price estimate.

3. Wafer prices decline at slower rate (+18%):

Heavy competition in the highly fragmented solar-wafer manufacturing industry combined with declining polysilicon costs have driven down wafer prices in recent years and will continue to do so in the years to come.

We currently estimate wafer prices to drop to about $0.52 per watt by the end of our forecast period but consolidation in the industry could rein in the price decline. If prices decline to reach $0.6 per watt over the same period, then this would mean an 18% upside to the current Trefis price estimate.

4. Strong growth in China wafer demand (+8%):

China is expected to be one of the largest growing market for solar energy in the years to come. This prompted us to forecast wafer sales of nearly 2.86 gigawatt (GW) by LDK in mainland China. If the Chinese government’s efforts to increase dependency on renewable power sources increase more than anticipated, and sales improve to 3.3 GW by the end of the same period, then this would signify an 8% upside to our price estimate

42% Downside Scenario: $7 Trefis Price Estimate for LDK Solar

1. Modules & Systems business grows slower (-14%):

LDK is one of the smaller players in the solar modules business in China, which is dominated by giants like Suntech Power and Yingli. It could face stiffer competition from these players in the future as it tries to expand vertically.

If revenues from this business rise slowly to only reach $2.2 billion by the end of the Trefis forecast period, instead of the $2.6 billion currently estimated, then our price estimate will see a 14% downside.

2. Faster decline in Modules & Systems business margins (-13%):

LDK is relatively new in the modules & systems business, and could end up incurring higher advertising and distribution costs to gain presence in the highly competitive solar market. This can hit margins more than we currently anticipate.

If margins reach 16% by the end of our forecast period, there will be a 13% downside to the Trefis price estimate.

3. Wafer prices fall faster (-7%):

Wafer prices have decline significantly over the recent past, and increasing competitive pressures due to low entry-barriers can further drive down prices in the years to come. If the revenue generated per watt of solar wafer by LDK falls to just below $0.50 by the end of the Trefis forecast period from the $0.52 we currently estimate, then our Trefis price estimate will see a 7% downside.

4. Solar wafer sales in China grows at slower rate (-8%):

While the Chinese government’s focus on solar energy will definitely drive growth in wafers sale in China, increasing competition can limit this division’s growth by a great extent in the years to come. If sales grow at a slower rate and only reach 2 GW by the end of our forecast period, then this would represent an 8% downside to the Trefis price estimate.

See additional details for our analysis of LDK Solar