MEMC Electronic Materials (NYSE:WFR): Upgrade to Buy & add to Top Picks Live, $18 target - Citigroup

Citigroup is upgrading MEMC Electronic Materials (NYSE:WFR) to Buy from Hold and are adding the stock to their Top Picks Live list with a Street high $18 price target (up from $15).

The move comes surprisingly after the co reported below consensus September results but more importantly, the management suspended EPS guidance due to the real estate accounting treatment of the direct sales/leaseback SunEdison projects.

- Citigroup says that while WFR suspended CQ4 guide, revs/EPS delta w/Street are due to acct’g timing in SunEd project biz w/core biz ahead of CQ3 expectations for the first time in a long while. Near term, even assuming flat operating profit in core wafer biz, EPS on a non- GAAP (apples-to-apples) basis looks at least in-line w/Street $0.30 and the value of the SunEd pipeline is crystallizing. Also, WFR finally controls its own destiny on costs & measured poly capacity expansion should add another lever to the model in 2011/2012. Into 2011/2012, using even a conservative set of assumptions and no growth in the SunEd pipeline, Citi estimates EPS power of at least $1.75. On SunEd, their checks and work now suggest this could actually be a >$2B revs business by 2012 w/EBITDA of >$500MM. While valuation is complex, this argues the segment is worth a lot more than the $2-3/share purchase price the Street seems to currently contemplate. Increasing CQ4:10 EPS (non-GAAP) from $0.28 to $0.41 with F2011 EPS increased from $0.81 to $1.59 (PF EPS $1.70) primarily due to firmer conviction on SunEd and could see biz worth >$10/share.

Coming into this Q, Citi says they had been positioning WFR favorably longer term, but have been still looking for more clarity on both its costs and the SunEd pipeline. While cost reductions are still necessary in 2011 to hit margin targets, they think this Q will represent an inflection point in this story. We think there is increasing evidence that this business model can drive at least $1.75 in EPS power within 2yrs if not much earlier. Additionally, costs appear to have turned a corner as internal wafering operations get up and running in 1H:11 and WFR starts to finally expand its polysilicon capacity more aggressively in 2011. This should add another degree of freedom on the upside to revs while the internal cost control on the solar wafer side should mitigate any unexpected negative margin surprises as has been the case the last few Qs.

What Happened — FQ3:10 (Sept) rev/EPS $503M/$0.08, light on surface vs. Citi $592M/$0.09 and Street $531M/$0.13. Better Semi/Solar Matls revs were more than offset by much lower revenues at SunEdison due to project timing. Mgmt withdrew its 2010 guide (and thus CQ4) due to accounting timing uncertainty in SunEd but division commentary suggests EPS at least in-line w/Street $0.30.

Positives — 1) Another operationally clean quarter; 2) poly capacity expansion appears well though-out and more measured than peers.

Negatives — 1) SunEd accounting complexity scares investors away/results in lower multiple; 2) semi/solar wafer margin targets still challenging in 2011.

Notablecalls: I suspect WFR will see green today following the Citi call. Here's why:

- It looks like the miss & guidance suspension have nothing to do with actual fundamentals and everything to do with timing.

- SunEd may be a near-term drag but looking further out, it could be one of the main value drivers for WFR. Citi estimates WFR could do $2bln in revs by 2012 and be worth $14-15 per share alone, which by the way is more than WFR sells currently. Citi is also toying with the idea of a SunEd spin-off at some point.

- Core business was ahead of expectations, which is something people haven't seen in a long time at WFR.

- What I like about this situation is the fact most of the analyst community is still Hold/Sell rated on WFR.

Anyway, WFR should see green today. How green? Well my guess is as good as anyone's these days.