MEMC Electronic Materials' Q2 Results Make Current Valuation Mystifying

| About: SunEdison, Inc. (SUNEQ)

MEMC Electronic Materials (WFR) announced Q2 2011 results after close of trading on August 3. Non-GAAP EPS came in at $0.29 per share, significantly higher than the $0.07 per share reported in Q2 of last year. The First Call consensus estimate was $0.20. However, stripping out a non-recurring net benefit of $0.23 per share, attributable primarily to the resolution of a customer contract dispute, produces a steady state result of $0.06 per share for the quarter.

The company emphasizes non-GAAP results to enable better understanding of the relationship between cash inflows with cash outflows rather than to divert attention away from unfavorable operational or financial issues (i.e., restructuring initiatives produced a headwind of only $0.03 per share in Q2). GAAP EPS was $0.21 per share.

Somewhat troubling was an adverse impact of $0.16 per share stemming from customers renegotiating/annulling two contracts for polysilicon and solar wafer supplies. This places MEMC between a rock and a hard place. On the one hand, the company undoubtedly does not wish to set precedents for other customers balking at contractual terms struck when polysilicon and solar wafer prices were much higher than today. On the other hand, the company likely does not wish to alienate customers by playing hardball and legally enforcing its contracts.

Solar wafer prices have cratered this year, yet MEMC’s wafer prices declined only 17% in Q2 because of multi-month supply contracts. It would not be surprising to see additional supply contracts broken, which would further pressure results in the Solar Materials division. The division’s normalized operating profit was down 49% year-over-year to $7.7M in Q2, and 2011 guidance for the division’s free cash flow is pessimistic.

However, guidance on operating profits and free cash flows for the second half of 2011 and full year 2012 in the Semiconductors division is optimistic. And the SunEdison pipeline continues to grow, in part because of the announced Fotowatio Renewable Ventures acquisition that is expected to close sometime in the next five months. SunEdison’s improvements are expected to come from greater operating leverage and better management of working capital.

Free cash flow in Q2 was $17M, and liquidity appears ample. Quarter-end cash balance was $652M, and the company projects a year-end balance north of $550M.

Revenue guidance for full year 2011 was revised downward by $100M, or about 2.8%, to a range of $3.3B to $3.6B, and EPS was also revised downward to a narrower range of $0.80 to $1.00 from the $1.00 to $1.30 provided just three months ago during a May 11 capital markets day presentation. Based on the mid-points of the two EPS ranges, the revision represents a 21.7% decline.

The company’s share price declined 63% between May 11 and August 3 and now trades 20% below tangible book equity value of approximately $8.76 per share. This seems undeserving. MEMC is generating positive GAAP earnings, thereby building shareholders’ equity, and assuming share dilution is not outlandish tangible book equity value should continue to grow. On June 13, when the stock closed at $8.67, I suggested it may be time to begin accumulating shares if for no other reason than the attractive valuation, and I stand by my recommendation. The market can remain irrational longer than an investor can remain solvent, but I expect the massive bear attack on MEMC to eventually run its course and is likely closer to the end than it was on June 13.

Disclosure: I am long WFR.

Additional disclosure: Readers should conduct their own due diligence prior to making investment decisions. This article reflects the personal views of the author, and it should not be construed as a solicitation or advertisement of any sort.