L-D-K, L-D-K, How Many Wafers Were Killed Today?

No, I am not about to embark on some anti-war propaganda, nor am I implying that LDK Solar (LDK) has anything to do with the messy conflict in the Middle East. What I am commenting on is the excessive growth of the solar industry that we are witnessing, and how this same prosperity could very well prove to be an Achilles heel down the road.

Photo:LoyCorp, Creative Commons, Flickr

As a manufacturer of multicrystalline wafers, LDK has enjoyed the benefits of being an upstream player in the solar space. It has shrewdly locked in supply contracts to hedge against volatile silicon prices and is churning out wafers at a steady clip. At the market close of September 26, LDK stock hit an all-time high of $73.95. Since then, however, things have taken a turn for the worst and the stock closed at $45.80 on October 11. This represents a 38% drop in two weeks. How did this happen?

Mr. Charley Situ, LDK’s former controller, resigned on allegations that management was inflating its inventory numbers and hence boosting its assets value. Specifically, Mr. Situ claimed that the company only had 750 tons of polysilicon in its inventory, instead of the reported 1,000 tons. Using a spot price of $250/kg, this translates into an inventory discrepancy of $57 million — $227 million vs. $170 million. Management has stood by its claim and has even hired a third-party to do a thorough audit of the inventory.

However, LDK’s problems likely run deeper than a “simple” inventory discrepancy. LDK claims it can manufacture wafers with as little as 25% virgin silicon. This keeps costs down but raises questions about its quality control. A recent article in Barron’s points out that several months ago, “LDK produced a batch of ingots so motley that testing instruments couldn’t even tell whether the resulting silicon was positively or negatively charged.” This anecdote could underscore the severity of the shortage of refined silicon in the marketplace, as LDK could be skimping on quality control and using lower quality feedstock in order to fulfill its lofty volume requirements for its customers.

Consequently, the inventory discrepancy could be a function of high-grade silicon versus poor quality silicon — Mr. Situ may not have wanted to include lower grade silicon in the inventory numbers, causing a lower inventory number. Management, on the other hand, may have claimed that there is nothing wrong with that, thus allowing for a higher inventory number. The completed audit, to be released shortly, will likely resolve this issue.

So what about the company’s stock? As of Thursday’s close, the stock was trading at $45.80, translating into a five-year PEG ratio of approximately 0.46. This represents a deep discount to its peers. Additionally, LDK has since managed to capture a $133-million contract to supply wafers to Chinalight Solar, so Chinalight Solar is one customer that is apparently not worried about potentially receiving junky wafers. Still, I would be wary about buying LDK stock right now, at least until the audit results are in. We don’t know what kind of negative feedback may be forthcoming from LDK’s other customers in regards to quality issues in its wafers.

Longer term, LDK should be able to recover from any roadblocks that the current situation could potentially be creating, as the company is in the process of building its own polysilicon capacity. LDK aims to develop 6,000 metric tons of polysilicon in-house by the end of 2008 and 15,000 metric tons by the end of 2009. As for right now, however, I would take a wait-and-see approach before buying shares of LDK.

But what implications might this have for the broader solar market, particularly among the Chinese players? Will similar problems arise in light of the silicon shortage? We will keep you informed as more developments unfold.

Site disclaimer

Disclosure: I do not own shares of LDK. I do not own a solar panel either.