We are maintaining our Neutral recommendation on MEMC Electronic Materials Inc. (WFR) with a target price of $4.25. MEMC witnessed weak segmental year-over-year growth in its third quarter, with a decline in its Solar Materials segment. Though a positive trend was noticed in its solar projects, a persistent decrease in polysilicon (raw material for solar chips) pricing and the overcapacity in the solar market remained overhangs.
MEMC is the leading producer of silicon wafers for the semiconductor industry, operating manufacturing facilities in Europe, Japan, Malaysia, South Korea, Taiwan and the United States. Its customers include all major semiconductor device manufacturers in the world be it in the memory, microprocessor, ASIC or foundry segments.
MEMC runs its business under three segments, namely Semiconductor Materials, Solar Materials and Solar Energy. The Solar Energy segment consists of SunEdison’s operations, which were acquired in November 2009.
The company internally produces polysilicon, the raw material used to make wafers. This gives it a competitive advantage as volatility in polysilicon prices would not affect it. But the continued decline in polysilicon prices is having other ramifications on MEMC’s business. For this reason alone, MEMC was forced to amend one of its long-term wafer supply agreements. Another major customer, Suntech Power Holding Co. Ltd. (STP) terminated its long-term contract with MEMC due to the constant price declines.
On the other hand, MEMC is seeing a solid trend in its solar business. Currently, MEMC is engaged in developing its solar energy projects mostly in North America and Europe. The company has already built a solar plant in Italy, Rovigo that happens to be the largest photovoltaic power plant in the region. We think that strong business ties with the European region will allow the company to capitalize on the solar prospects in Germany and Italy. MEMC is also building its position in the Chinese solar market.
The solar industry remains highly dependent on subsidy or tariff programs for the overwhelming part of installations. Any significant reduction in subsidy programs will therefore result in earnings pressure on the company’s solar-wafer and solar installation business, since prices have to be kept low in order to encourage organizations to purchase. Until now, Italy, Germany and the U.K. have reduced their tariff rates considerably. This could affect MEMC’s solar business.
Moreover, another reason for the concern is that the solar market has stepped into the oversupply zone. Though market sources are expecting a demand surge in China, some believe that it will not be sufficient to sweep away the ongoing oversupply.
The ongoing overcapacity situation in the solar market will continue to impact pricing and profitability. Hence, we believe it will be hard for MEMC to significantly improve its earnings in the near to intermediate term. Moreover, MEMC could face headwinds from the continuous capacity expansion to produce polysilicon.
To fight the lowering of ASPs, MEMC is now planning to reduce its workforce globally and cut production capacity at some of its fabs. The company is also preparing to merge its Solar Materials and SunEdison businesses. This effort will minimize operating costs in the weak Solar Materials segment. MEMC could make more profit by purchasing solar chips externally.
We are now taking a wait-and-see approach and would look forward to MEMC’s plans to get operational.
Currently, MEMC has a Zacks #3 Rank, implying a short-term Hold recommendation.
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