MEMC Offers Back-Door Play on Solar Boom

I see a handful of likely reasons for the decline. None seems overly worrisome, leaving the stock an apparent bargain at the current price. More on that in a moment.

Silicon wafers are the foundation of most electronics, from cellphones to laptops to power-steering systems. They're also used to make solar panels. St. Peters, Mo.-based MEMC makes wafers ranging in size from a small saucer to a dinner plate (bigger discs are better, since more circuits can be produced from them at once), and is among the lowest-cost producers in the industry. Trailing 12-month sales for the company total about $2 billion. Management figures the world-wide wafer market generates $10 billion in yearly sales for electronics and $4 billion for solar cells.

The rise of oil prices in recent years has led to increased demand for solar energy, which in turn has created a run-up in silicon prices that makes oil's climb look modest. In 2000 a kilogram of "polysilicon" could have been yours for $9. By the time of my first column on MEMC nearly four years ago, poly was up to about $30 a kilogram. By last November's column it had soared to $200. Now it's more than twice as expensive. That has been a boon for MEMC, which unlike many of its competitors makes most of its poly. Last year earnings per share jumped 63%. This year they're seen increasing 30%.

Now let's look at some likely concerns for stockholders.

First, new competitors are piling into the market, especially in China. That could lead to a glut and subsequent plunge in prices. Jeff Osborne, who covers MEMC for Thomas Weisel Partners, an investment bank, thinks any oversupply will be short-lived. He notes that it takes only about four to six months to add solar cell production capacity, but two to three years to build new polysilicon capacity. Of around 70 new poly plants proposed in China, only 20 or so had broken ground by February, according to Osborne. Few analysts expect poly prices to climb higher, but the looming falloff seems likely to drive higher solar volumes.

Second concern: MEMC had a financial hiccup last quarter. The company's Pasadena, Texas, facility saw a 20% or so decline in output on increased maintenance. Ironically, it might have been due to the company's torrid pace of production — the equivalent of a car that needs its 100,000-mile tune-up a year earlier than expected. Management preannounced a shortfall, and then produced one. First-quarter sales, reported April 26, increased 14% and earnings rose 16%, but per-share earnings of 84 cents missed already-lowered estimates by a penny. Earnings misses are a big deal for a momentum stock. J.P. Morgan changed its recommendation on the stock to Neutral from Overweight on April 30.

Other worries don't seem as severe. Some investors foresee a transition to solar cells made from "metallurgical" silicon, which has other elements mixed in to extend production, sort of like watered-down liquor. Management says it has experimented with metallurgical silicon and found the result unimpressive. Blends work well early on but tend to degrade faster; solar panels are generally expected to function for at least 25 years. And metallurgical silicon might seem like less of a cost-saver when silicon prices fall.

There's also the matter of an insider stock sale. Chief Executive Nabeel Gareeb dumped $40 million worth of stock earlier this month. That doesn't seem as negative as it sounds, though. A look at past transactions suggests that since 2002, Gareeb has consistently exercised options contracts as they have become vested and sold the stock right away. He must still hold 100,000 shares per the terms of his employment, but also has options on 2.9 million more shares, no doubt creating a keen interest in growing the stock price. Those options could add to the share count, currently at 228 million. But the company can easily afford to offset that with repurchases. It generates $150 million to $200 million in free cash each quarter and spent $79 million last quarter on stock and $63 million the quarter before.

MEMC isn't a perfect picture, but its stock goes for only around 16 times this year's earnings forecast, a smidgen more than the broad market's price. And, it's producing at least double the market's earnings growth. If you've been tempted by high-priced solar stocks of late, here's one that still seems reasonable. The company also generates an impressive return on the capital it puts to work: around 35%. That recently earned MEMC a spot on my Efficiency Experts stock screen. Have a look at all eight survivors if you like and run the search anytime using SmartMoney's stock screener and the full list of demands.

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