Can MEMC Ever Find Full-Cycle Profitability?

By Stephen D. Simpson, CFA | May 09, 2012 AAA

Some businesses just intrinsically swing from shortages to a surplus over and over again, dragging suppliers through a roller-coaster of boom and bust cycles. That's broadly true of semiconductor equipment companies, and particularly true of MEMC Electronic Materials (NYSE:WFR) - a leading supplier of semiconductor wafers. While the wafer business is what it is (an inherently up-and-down business), bulls are hopeful that the company's SunEdison solar business can be a long-term sustainable growth driver.

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Not Much Joy in the First Quarter
Right now, MEMC is still in the midst of restructuring, and overall conditions in the wafer and solar markets are not especially good. Consequently, not a lot was expected of MEMC this quarter.

Revenue dropped 29% from last year's first quarter and 28% from the fourth quarter on a GAAP basis. The semiconductor wafer business saw a 14% revenue decline, while the solar business saw revenue drop 37%. While the company did recognize a meaningful polysilicon sale, both volumes and pricing were weak across both businesses.

With weak volumes and pricing, it's no great surprise that MEMC's profitability is also suffering. Gross margins dropped almost five points from the year-ago level and the company reversed a year-ago operating profit into a loss. The operating losses in semiconductor and solar businesses were roughly equal at $12.5 million and $10.5 million, respectively.

SEE: Understanding The Income Statement

No Reason to Expect a Major Semiconductor Turnaround
There's no particular reason to expect a big turnaround in the wafer business anytime soon. While major chip producers like Samsung, Intel (Nasdaq:INTC), and Taiwan Semiconductor (NYSE:TSM) do seem to expect a recovery in chip demand, there's more than enough wafer capacity out there to absorb that incremental improvement.

The reality of the wafer business is one of constant boom-bust cycles. Wafer companies like MEMC, Shin-Etsu, Siltronic and SUMCO usually see strong pricing every seven to 10 years as producers transition to new wafer sizes, but prices can drop significantly in the interim. That puts the same sort of pressures on MEMC as Corning (NYSE:GLW) has seen for years in its glass business, and the key to long-term success is trying to find an expense structure that keeps the company out of trouble in the bad times.

SEE: Earning Forecasts: A Primer

Still Waiting for Solar's Day in the Sun
MEMC's best shot at sustainable growth will have to come from its SunEdison business - one of the largest solar energy project designers and installers in the country. Unlike First Solar (Nasdaq:FSLR), MEMC is basically "module-agnostic," and there's a pretty sizable backlog of projects yet to be installed. Unfortunately, there's been a large pipeline of capacity for a long time now, and it remains to be seen how quickly any of this can translate into real earnings.

The Bottom Line
Although MEMC has some near-term liquidity challenges, I expect that the company will work though them. The longer-term concern, though, is whether the company can find an appropriate expense structure for its wafer business and whether the SunEdison business really has the potential to generate long-term economic returns; the demand for solar energy may well develop as expected, but there are no guarantees that the profitability will be there.

Valuation on MEMC involves a lot of guesswork given the highly cyclical nature of wafers and the uncertainty of the long-term profitability of SunEdison. What I can say, though, is that this company has often traded at around 1.5 times tangible book value and that would point to a near-term fair value of around $4. With both the wafer business and solar business likely near a bottom, this could be an interesting multi-year recovery story for aggressive investors.

SEE: 5 Must-Have Metrics For Value Investors

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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