Solar Sector's Black Box: MEMC Electronic
Updated from Monday, Feb. 1
SAINT PETERS, Mo. (
) -- The black box of the solar industry may be revealed on Tuesday.
No, it's not the net impact of Germany's feed-in tariff reductions to the entire solar industry.
MEMC Electronic Materials
(WFR)
will report its earnings, but the No. 1 priority of many analysts that cover MEMC is not the backward-looking numbers from the fourth quarter. The market is awaiting details on SunEdison, the private large-scale solar project developer that MEMC acquired in Oct. 2009.
Because SunEdison was a private company, analysts lack any information on the financial picture of the company. That is about to change, as MEMC sets about convincing investors and The Street that the SunEdison deal -- which some analysts still refer to as a "mystery" -- will be an accretive deal for MEMC shareholders.
"Clarity on the SunEdison deal has been holding MEMC back,'" said Ardour Capital Management analyst Adam Krop.
The MEMC picture is complicated headed into the earnings season. Getting a read on SunEdison may be the big ticket item, but analysts are also looking for resolution to silicon plant production problems that plagued MEMC in its Pasadena location last year. What's more, the much-feared German reductions in solar feed-in tariffs will also be important to the MEMC outlook.
As a result, the earnings season points of concern for MEMC are two parts company-specific, and one-part European feed-in tariff-related.
The critical question related to SunEdison is how MEMC integrates the solar project developer without deteriorating the gross margins to which investors have become accustomed. Engineering, procurement and construction work (EPC) is a low margin business, and it is the type of business in which SunEdison specializes.
MEMC's balance sheet should allow SunEdison to have more leverage in debt financing. What's more, SunEdison could theoretically partner with a solar-module company like
Suntech Power
(STP)
, which is already using MEMC solar wafers, completing a business loop that would benefit MEMC.
Still, the question remains: Will SunEdison be accretive in generating earnings per share for MEMC? MEMC will also be able to sell its own wafers into the SunEdison project pipeline, but right now, the potential benefits of the deal are all theoretical, or logical speculation, and analysts are hungry for more information.
J.P. Morgan analyst Chris Blansett said the MEMC balance sheet will definitely provide SunEdison with help on the financing side of the equation, but wonders if that can offset the larger trends in solar and gross margin pressures of a lower margin SunEdison business? "If MEMC doesn't break out the numbers, MEMC could print a nice top line but an ugly gross margin number because of SunEdison," Blansett said.
Blansett pointed to lower fuel prices than one year ago, the fact that the U.S. is a particularly difficult country in which to develop solar projects given state and federal regulator regimes, and the continued high cost of solar electricity relative to other forms of energy, as all complicating the outlook for MEMC, and making it impossible for MEMC to simply say that the leverage in debt financing it offers SunEdison answers all the questions about the deal.
The central issue is margin compression. "You have to expect the margins to come down, and see if top-line revenue grows fast enough to offset margin declines," J.P. Morgan's Blansett said.
Blansett explained that MEMC had gross margins as high as 70% at one time, which plummeted to as low as 6% in the last quarter due to problems at its Pasadena plant. Operating expenditures were much higher than anticipated after MEMC discovered that the plant was not operating at a stable level, and that financial constraint of additional investment was compounded by the resultant lower output. Blansett said the good news is that in the past MEMC has pre-announced when there was a major plant production problem, and they have not done that this quarter.
The J.P. analyst said that because of the problems at the plant in 2009, 2008 was the last year during which MEMC had stable blended gross margin levels -- of 50%. The solar portion of MEMC's business had a gross margin level of 65% in 2008.
"All we know is that both the semiconductor and solar gross margins have gone down," Blansett said. "Assuming that there is a stable economic recovery, and the semiconductor industry gets better with a return of pricing leverage, and solar prices don't erode significantly, MEMC can get back to 30%, but nowhere near 50%," the J.P. Morgan analyst said.
Ultimately, the best thing that SunEdison can do this earnings season is provide a compelling rational for a deal that the market is still trying to understand.
However, given the evolving feed-in tariff situation in Germany and other European nations moving to reduce tariffs, MEMC could post solid earnings in the next two quarters, yet the real outlook for MEMC -- as for all the solar sector -- will still be a question mark until the second half of 2010.
J.P. Morgan's Blansett has MEMC at an underweight and said he would find it surprising if, even after opening up the black box of the SunEdison deal, MEMC can provide him with an incontrovertible rationale this earnings season to not still fear the German solar reaper.
"Is there a stable global subsidy platform for solar after Germany's cuts? SunEdison gross margins could come down even more," Blansett cautions.
Caution will be the rule even in what is expected to be a relatively healthy solar earnings season. Even with the SunEdison black box seeing daylight, the German situation is will continue to dominate the solar spotlight.
-- Reported by Eric Rosenbaum in New York.
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