MEMC Electronics In Good Position to Leverage Vertical Integration (WFR)

Includes: SUNEQ, TSM
by: Travis Johnson

MEMC Electronic Materials (WFR) just released 2005 full year and 4Q earnings, and they sure look pretty nice to me. They are still preliminary due to the tax confusion they've had this past year, but it sounds as though the annual figures, if not the 4Q, should at least be accurate, which is fine with me. And if you believe the wacky after hours trading, the market likes it just fine too -- up 5 or 6% at the moment, even after climbing more than 3% pre-earnings during the day today.

I guessed in my annual checkup that WFR might have gone up too far, too fast and be due for a little pullback of some kind ... but not if they're going to continue putting out good results and very solid guidance like this. If that continues, I'm very happy to have guessed wrong.

Their guidance for next year is in a very broad range, which makes sense given their reliance on overall demand in the volatile semiconductor industry and on pricing that they can't entirely control, but the low end of their range is just two cents lower than the average street estimate (at least, according to Yahoo Finance). The high end of their range is $1.70 a share, which blows away the high analyst's $1.56. They're putting together improving margins, growing sales, investing in dramatically increasing their polysilicon capacity and defending their intellectual property to differentiate their products, and paying down debt ... all good.

What struck me most was their announcement, which I hadn't heard before, that they're aiming to double polysilicon capacity to help them reap the advantages of a vertical supply chain even further, and they're really focusing much more than in the past on supply to the red-hot solar market.

Here's the quote from CEO Gareeb that was in the earnings release, in case you don't feel like reading the whole thing:

Although MEMC has been quietly working on expanding its polysilicon capacity, we are now formally announcing that we are targeting our polysilicon capacity to grow from approximately 4,000 metric tons per year to approximately 8,000 metric tons per year over the next three years, as dictated by market conditions. The majority of this capacity will be usable for both semiconductor and solar wafer production and is anticipated to be accomplished within the constraints of our business model.

This will provide us with significant opportunities to take advantage of a vertically integrated supply chain as compared to our competition, by providing security of supply for semiconductor wafer expansions and significantly increasing our penetration of the solar market. This polysilicon capacity expansion coupled with the opportunities available in the semiconductor and solar wafer industries would support an approximate doubling of our first quarter 2006 revenue run rate by the end of the decade, if market conditions allow.

I added the bolding. Still a little pie-in-the-sky, but I like that they have an ambitious plan.

I was pretty optimistic about WFR after seeing Taiwan Semiconductor's great earnings report and commentary on the explosion of demand for semis in late 2005 and into this year, which reinforced what we're hearing from most of the industry. It looks like WFR is really in good position to leverage its vertical capabilities and it's exposure to tight polysilicon supplies to continue growing and, as importantly, to continue expanding their multiple now that management is beginning to run a tighter, very low debt ship.

I think Wall Street can trust this company again, and though I'm nervous about being aboard if the semiconductor industry has another inventory glut, I'm hoping there will be some significant warning signs before that really comes into play in this cycle.

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