Wednesday, June 24, 2009

MEMC Electronic (NYSE:WFR): Downgraded to Underweight at JP Morgan, Citi highlights an overnight acquisition in the space

MEMC Electronic (NYSE:WFR) is getting some interesting comments from two tier-1 firms this morning:

- JP Morgan is downgrading the stock to Underweight from Overweight with a price target of $12.

According the the firm the downgrade is due to faster than expected ASP declines in all of the company’s product lines. They also believe the overall supply of polysilicon will far exceed that of demand for the remainder of C09 and well into C10 driving down spot poly as well as semi and solar wafer pricing. We had previously est. spot poly would reach the $60/kg level at the end of the year, a level that now looks to be reached sometime this summer. JP Morgan now believes poly could reach the $35/kg level by the end of 2009, a price point lower than the manf cost of many new poly makers & at relative cost parity of the large incumbent poly makers.

An oversupply of polysilicon seems inevitable given the sheer volume of polysilicon that is expected to come on-line this year. A number of long lead time polysilicon factories will start production this year, but unfortunately actual solar PV demand today is a lot lower than last years expectations which initially drove the aggressive capacity expansion. This is resulting in a massive oversupply of polysilicon which could last for years if current announced capacity expansion plans are not scaled back.

Firm thinks MEMC may need to revise its solar wafer contracts, again given the continued decline of spot poly pricing. We believe a spot market price of under $50/kg would make MEMC’s current supply contracts unpalatable to its current solar wafer customers and could put them at a competitive disadvantage given that poly is usually more than 50% of the cost of a solar wafer. They now think spot prices for poly are likely to fall well below the $50/kg range in C2H09 forcing MEMC to once again lower its spot solar wafer prices in order to remain competitive.

Semi Wafer pricing is also being negatively impacted as MEMC competes with non-vertically integrated semi wafer makers. Both Shin-Etsu and SUMCO buy poly on the open market and the continued decline in spot pricing of the material allows both of these companies to pass along cost savings to their semi device customers. This allows these two companies to buffer ASP decline while vertically integrated companies such as MEMC and Wacker are forced to accept declining margins.

Reducing C09/C10 estimates on lower product ASPs & margins. New C09 rev/EPS ests are now $979mn/$0.19 vs. $1.014bn/$0.24 prior. New C10 rev/EPS ests are now $1.36bn/$1.06 vs. $1.41bn/$1.15 previously. WFR trades at 2.0x its P/TBV.

- Citigroup notes that overnight, GCL Silicon – #1 Chinese polysilicon manufacturer – announced that it was being acquired by its parent in a deal worth ~$3.4B.
The deal would provide some liquidity to fund GCL’s future expansion following its failed IPO last year. While some may argue this is a questionable indication of market value, at a valuation of ~$160/kg (based on estimated capacity (not production)) or ~3x sales (assuming ~$50-60/kg poly) the firm thinks this highlights the value that in-the-ground polysilicon assets continue to command even in this tough demand environment.

WFR valuation analysis — In conjunction with their earlier work, if they comp WFR's polysilicon business to GCL’s takeout multiple, they estimate WFR’s solar biz is worth ~$2.5B or about 3x the pure replacement value to replicate the assets based on capex. Adding back replacement value of its semis biz (~$0.75B based on ~$1MM per 1k wafers/month of 300mm capacity and ~$300k per 1k of 200mm) and ~$1.3B of net cash on the balance sheet, they come to a total valuation of roughly ~$20 per share for WFR, or slightly higher than the stock trades today.

Stock summary — Firm notes they are compelled to get more constructive on this longer term given much more favorable risk/reward balance driven by what they estimate is ~$2.00-2.25 cross-cycle EPS, replacement/takeout value including cash in ~$20 range, and some signs of poly price stabilization. That being said, they are still awaiting more confirmation of wafer inventory work-down and a beat/raise for estimates moving forward. Model unchanged, Maintains Hold, $15 target.

Notablecalls: This is surely a puzzling situation. The acquisition of WFR peer kind of lessens the power of the downgrade from JP Morgan.

Despite of his otherwise fairly lousy track record of covering WFR, the JP Morgan analyst Chris Blansett makes some interesting points regarding the supply/demand dynamic. Looks like there is very little hope of things getting better over the next year or so. So the downgrade looks warranted.

On the other hand the large deal that took place in China overnight highlights a similar possibility in case of WFR. It wasn`t too long ago we had rumours of BASF AG sniffing around.

All in all, I think the downgrade will work today but the stock remains prone to squeeze. This thing isn`t going down without a decent fight.


Zeumith said...

Wow, you're even posting charts now - how interactive. Great work.

notablecalls said...

being sarcastic, eh?