Monday, July 26, 2010

MEMC Electronic (NYSE:WFR): Upgraded to Overweight at Barclays; Short squeeze?

Barclays is upgrading MEMC Electronic (NYSE:WFR) to Overweight from Equal-Weight with a $16 price target (prev. $14).

Shares have not participated in the recent solar rally, primarily due to concerns over Q2 earnings miss and low upside risk to 2010 guide. Although we do not anticipate any upside to Q2 results, checks indicate 2H upside from solar/SunEd segments exists. Positive '11 earnings impact (~$0.55-$0.60) from in-house wafering is also not completely baked into street estimates in Barcap's view. Shares are trading at a discount to poly peers (OCI, GCL). With ~$3/share cash on hand, solid progress on SunEd/solar segments and robust outlook for semis segment, risk reward now appears attractive (pot'l upside to $16, downside to $10, representing risk-reward of 3:1), in firm's view.

1) Robust Fundamentals: Demand from both semis and solar segments remains very strong. Checks indicate that MEMC is completely sold out for the rest of the year and is currently trying to procure poly in the spot market to meet excess demand. One poly competitor told Barcap that "demand is limitless for MEMC" - obviously, most poly suppliers are focused on meeting excess demand from existing customers and as such they do not see significant upside to Q2 results (from extra poly purchases in the spot market). That said, they believe poly/wafer pricing is looking good and despite higher tolling costs, MEMC is likely able to maintain margins. Checks with several solar customers, for instance, indicate that wafer prices were up sequentially in Q2 and could likely remain flat or even increase sequentially in Q3/Q4. Fundamentals within semis segment also appear to be relatively robust and they expect pricing to be up mid-high single digit percentage points sequentially in Q3/Q4. None of the major semis competitors are adding capacity and as such they expect pricing outlook to remain relatively stable, even into 2011. Finally, fundamentals for SunEd business appear relatively strong in markets such as Italy and the US. Barcap's current model assumes $5.50/W system ASP for SunEd in 2H10. Greater mix of Italian systems business could lead to pricing/volume upside, in their view.

2) 2011 Positive Earnings Impact from In-house Wafering Not Completely Priced In: MEMC does not have an in-house wafering facility and as such has to use third party wafer suppliers to convert poly into wafer – these conversion (or tolling) costs are rising and as such, negatively impacting 1H10 solar business gross margins. Barcap forecasts MEMC’s solar business revenues to reach $740 million this year – assuming $0.85-$0.90/W wafer ASPs; this would translate into ~840MW of wafer shipments, but only $55 million net income. For comparison purposes, they expect Chinese wafer supplier Renesola (SOL) to ship 750MW worth of wafers, but generate $150 million net income. They forecast wafer tolling costs of ~$0.50/W in 2010 vs. in-house wafer processing cost of ~$0.28/W for Renesola. This difference in poly processing cost is equivalent to ~$40/kg poly cost difference. In other words, a pure-play wafer manufacturer (Renesola) buying poly at $60/kg in the spot market today would have the same wafer cost structure as a poly manufacturer that has a poly production cost of ~$20/kg. Firm expects this dynamic to change once MEMC brings wafering in-house from 2011. For 2011, they are currently forecasting ~750MW of solar wafer shipments – assuming MEMC brings wafer costs down to levels similar to Chinese wafer competitors (at least ~$0.20/W reduction), they expect positive pre-tax earnings impact of $150 million. Assuming 15% tax rate and 225 million shares outstanding, net positive earnings impact would equate to ~$0.55-$0.60/share, which is not currently fully priced into shares, in our view (our above-consensus estimates assume $0.28 positive earnings impact). Management expects processing costs to be even lower – between $0.20/W and $0.25/W. Higher wafer shipments or lower processing costs could result in additional positive earnings impact.

Low Sentiment – Relatively High Short Interest Levels: Short interest on MEMC shares is at record levels (5-year high). Investors expect Q2 results to disappoint and remain concerned about 2H10 guidance, given rising tolling costs. Barcap also notes that shares have not participated in the recent solar rally. They expect sentiment to improve, once investors become comfortable with execution and get a better understanding of 2011 earnings power. Execution on in-house wafering ramp should enable the company to mitigate a $40/kg poly price decline and still maintain earnings. Clearly, poly prices are not declining by $40/kg next year ($20/kg decline is likely to be the worst case). As such, they expect solar earnings to grow next year (as opposed to current assumption of flat earnings) and drive positive estimate revisions.

Notablecalls: I looks like WFR may be setting up for a bit of a short squeeze. Analysts are downplaying the potential impact of the Q2 miss while short interest stands at 5-year highs.

I also like Barcap's comments regarding 'In-house Wafering' which could add ~$0.50-0.60 EPS. Put a modest 10x multiple on that and you have $5-6 bucks of upside. Not bad for a $10-11 stock, eh.

One to watch. Could trade over $12.00 level today.


Kileheias Blog said...

Down 15,36% today @ 13:50 hrs....

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