Summary

• DAQO New Energy is now a cost leader in the solar polysilicon industry.

• As of Q1 2014, the company is generating EBITDA at an enviable $10 per KG and is likely to continue to earn at that rate for the next several quarters.

• Given the cost advantage, the company has a realistic chance of becoming an industry volume leader by 2017.

DAQO New Energy (DQ) is a microcap, Chinese, upstream commodity polysilicon player in the solar industry. Now that is a sentence chock-full of negatives! With all these negatives, one might wonder, why they should even take a look at this stock.

The company's past is checkered and it has been one of the many underperformers of the last solar cycle. DAQO, along with its peers, have been brutalized in the last industry cycle when the Polysilicon ASPs fell from around $400/KG in 2008 to $15/KG in 2012. By 2011, polysilicon spot market prices dropped below cash costs of many vendors and, consequently, many companies went out of business and much of the industry's poly capacity became uncompetitive and mothballed. DAQO, with one of the better cost structures in the industry survived but the company has not posted a profit since Q3 2011. While the company has outperformed its peers in recovery it has still been a net loser

That stock started outperforming its peers late last year as the polysilicon industry snapped out of its funk and as investors started realizing that the company's Xinjiang plant may have a cost structure that can get the company back to profitability. For its new manufacturing facilities, DAQO secured some of the lowest electricity rates in China from the local government. Given the high power consumption of polysilicon plants, low energy rates can be the most important factor for siting a polysilicon plant.

In Q1 2014, the company posted net income of $2.6M with income per ADS of $0.38. Excluding nonrecurring costs related to the non-operational Chongqing polysilicon plant and bad debt reversal, the profitability would have been higher by about $2 million. DAQO returned to profitability much earlier than prior management guidance. However, a change in accounting for facilities' depreciation was the main reason for the positive earnings. This change is not unreasonable based on current industry standards for depreciation and is similar to many US company schedules. This accounting change increased useful lives of DAQO's assets for financial purposes and reduced depreciation expense on an ongoing basis by about $4.7 million per quarter. This accounting change may be a cause for some healthy skepticism but we believe is not very consequential to the company's thesis.