According to Oaktree Capital Management's 13F report for the first quarter of 2023, the firm run by Howard Marks (Trades, Portfolio) placed a significant bet on the future of green energy by buying 1,056,121 shares of Daqo New Energy (DQ, Financial), a prominent global solar photovoltaic industry player.
Investors should be aware that 13F reports do not provide a complete picture of a guru’s holdings. They include only a snapshot of long equity positions in U.S.-listed stocks and American depository receipts as of the quarter’s end. They do not include short positions, non-ADR international holdings or other types of securities. However, even this limited filing can provide valuable information.
With its cutting-edge manufacturing capabilities and strong government ties in China, Daqo presents a compelling stock to take advantage of the world's growing appetite for clean power solutions.
Surging solar outlook
The solar energy sector is expected to experience substantial growth going forward. For example, Research and Markets estimates an 11.93% compound annual growth rate (CAGR) for the sector through 2028, driven by a combination of policy support, energy security concerns and improving competitiveness against fossil fuel alternatives.
The solar industry has projected capacity additions of 341 to 402 gigawatts in 2023 according to SolarPower Europe's outlook. This would represent a remarkable growth rate of 43% if achieved. At this rate, by the end of the decade, the world could install as much as 1 terawatt of solar annually, with SolarPower Europe's estimates suggesting up to 800 gigawatts per year by 2027.
Further, solar photovoltaic (PV) capacity is expected to drive the majority of global renewable capacity additions, accounting for two-thirds of the projected increase in 2023 according to the International Energy Administration. This trend is supported by declining module prices, greater uptake of distributed solar PV systems and policy initiatives promoting large-scale deployment. Residential and commercial PV installations are set to exceed the deployment of onshore wind, becoming a significant contributor to overall solar growth.
Notably, China is the global leader in renewable capacity installations, contributing almost half of all new renewable power capacity worldwide in 2022. By 2024, China's share will reach 55% of global annual renewable capacity deployment. The country is also expected to dominate offshore wind projects, accounting for almost 70% of new installations globally by 2024.
While still lagging behind, the United States is poised for a rebound in capacity additions, with wind and solar PV installations set to increase by around 40% in 2023 according to the IEA.
While the solar sector faces challenges such as rising interest rates, higher investment costs and supply chain constraints, positive market developments, policy support and increasing fossil fuel energy prices are expected to outweigh these obstacles. The declining levelized cost of electricity (LCOE) for solar, combined with its competitiveness against fossil fuels and nuclear power, continues to drive its growth. Furthermore, ongoing efforts to streamline permitting processes, improve construction timelines and strengthen grid connections will help accelerate solar deployment.
In an accelerated case, global renewable capacity additions could reach 550 gigawatts in 2024 according to an IEA executive summary, almost 20% higher than the main forecast. This scenario assumes faster implementation of policies and incentives, particularly in residential and commercial PV installations.
Oaktree's investment strategies
After closely researching Oaktree Capital Management's investment philosophy, I believe Daqo New Energy is a good fit for the investment firm's strategy as it can capitalize on the long-term growth of the solar energy market.
Oaktree's emphasis on risk control and consistency align with its goal of superior performance with less-than-commensurate risk. By prioritizing risk management, Oaktree aims to deliver consistent results over time. This approach matches well with Daqo New Energy, as the company's solid financials and established position in the global solar PV industry indicate stability and potential for long-term growth.
Oaktree believes in capitalizing on market inefficiencies and specialization to achieve superior investment results. Daqo New Energy's focus on high-purity polysilicon for the solar PV industry presents an opportunity in a less efficient market. Daqo's technical advancements and low-cost production capabilities position it as a leading player in the industry, with strong relationships with policymakers in China, a key market for renewable energy.
Furthermore, Oaktree's disavowal of market timing aligns with its commitment to staying fully invested in attractively priced assets. While market fluctuations and China's lagging stock performance may have put pressure on Daqo's shares in recent months, Oaktree's long-term perspective allows it to focus on the company's solid fundamentals and growth potential. As China's efforts to transition to green energy continue, Daqo's position as a leading polysilicon manufacturer and its relationships with policymakers could drive its growth in the future.
Daqo New Energy's recent results
Daqo had a productive first quarter of 2023, producing 33,848 metric tons of polysilicon. The company is poised for significant growth as it completes Phase 5A in Inner Mongolia, which is expected to boost its production capacity. By the end of June 2023, Daqo aims to reach full capacity, increasing its total polysilicon nameplate capacity to 205,000 metric tons annually. This expansion is projected to result in a substantial increase of 30% to 36% in production volume for the second quarter of 2023, with an estimated range of 44,000 to 46,000 metric tons. For the full year of 2023, Daqo expects to produce approximately 193,000 to 198,000 metric tons, marking a growth of 44% to 48% compared to the previous year.
Source: Earnings Presentation
For the quarter, the company generated $490 million in Ebitda. The company's cash balance improved to $4.1 billion, with a combined cash and banknote receivable balance reaching $4.9 billion. Daqo maintained a robust gross margin of 71.4%, which reflects its outstanding quality and cost structure.
Notably, the solar photovoltaic industry experienced a seasonal slowdown in January 2023, but demand and prices rebounded in February due to lower module prices.
Daqo anticipates continued overall solar PV demand growth in the coming quarters, driven by cost reductions in solar PV products and increasing capacity expansions by downstream manufacturers. The company also highlighted a rising demand for high-quality N-type polysilicon products, which Daqo believes it can capitalize on due to its ability to produce the required polysilicon for next-generation technology.
Daqo has been actively investing in capacity expansion projects, particularly the Inner Mongolia Phase 1 and Phase 2 projects, which require significant capital expenditure. Each project will cost around $1.4 billion, with completion expected in the coming years.
Daqo has implemented a share repurchase program, having already spent $85.1 million to repurchase approximately 1.688 million American depository receipts. The company expects a substantial dividend from its subsidiary, Xinjiang Daqo, which can further support its improved share repurchase plan.
While shipment volumes were low in the past two quarters due to slow sales during the Chinese New Year and reduced capacity of downstream wafer producers, Daqo expressed optimism for the second quarter, citing signed contracts for more than 20,000 tons, which indicates higher shipment volumes. This positive trend suggests a rebound in demand.
The average selling price (ASP) for polysilicon was $27 per kilogram in the first quarter, but investors should expect a slight decline in the second quarter. Zhang also noted a price difference between N-type and P-type polysilicon, with N-type commanding a premium. The price difference could benefit Daqo, as the company focuses on selling more high-quality N-type polysilicon. Looking ahead, Zhang expects the ASP to stabilize in the third quarter, but the fourth quarter could present challenges due to seasonal factors and bargaining dynamics between silicon and wafer producers.
Forward-looking analysis
In the growing demand for polysilicon, driven by the increasing adoption of solar energy, Daqo aims to differentiate itself by selling high-quality N-type polysilicon and achieving a higher ASP compared to its competitors. The supply-demand dynamics and expansion of silicon output in China will influence pricing trends in the coming years. Daqo's focus on quality, cost control and a strong balance sheet positions the company well to navigate potential challenges.
Additionally, Daqo acknowledges its peers' aggressive capacity expansion plans, influenced by funding availability and market conditions. The success of these projects depends on demand and polysilicon pricing. If market conditions remain favorable and demand stays strong, Daqo may consider accelerating its capacity expansion plans, including the Inner Mongolia Phase 2 project. However, if pricing becomes less attractive, the company will delay its project expansion to avoid hastening capacity expansions. The approach allows Daqo to assess market dynamics before committing to expansion plans, potentially mitigating risks associated with oversupply.
Daqo's cost optimization efforts are evident in the gradual reduction of production costs. The ramp-up of its Inner Mongolia facility, which offers manufacturing efficiency and an updated process, presents an opportunity for further cost reductions. Daqo's internal plan to produce silicon metal could significantly impact its cost structure. By reducing reliance on external suppliers, Daqo expects cash costs to decrease from around 45 Renminbi ($6.31) per kilogram to ¥37 to ¥38 per kilogram. The cost reduction would enhance Daqo's competitiveness in the market.
