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MEMC Electronic Materials


may be providing a model for companies hit by rising commodity prices -- control your own supply chain.

Shares of the silicon-wafer manufacturer jumped again this week to sit at just under $20 -- a five-year high -- as investors see good things from rising silicon prices.

While MEMC makes wafers, it also makes its own polysilicon, the central building block of semiconductor chips and the main ingredient used to make the wafers used to build microchips for electronics gear.

Polysilicon has become scarce due to capacity constraints and

growth of the solar energy market, which also uses the material to make solar panels. As a result, polysilicon prices have pushed up to more than $45 a kilogram from the mid-$30s just 12 months ago. And prices are seen reaching $60 a kilogram next year.

Since MEMC makes 90% of its own poly, it appears to be in great position to pass along most of these rising prices to customers.

This possibility has been apparent for months, but investors have recently flocked to MEMC's shares as the supply and demand imbalance has become more apparent. Normally an issue that remains far back in the electronics supply chain and well removed from the end customer, the dynamic is attracting increased scrutiny from the mainstream.

In July, CEO Nabeel Gareeb said during the company's earnings conference call that customers had yet to try engaging in early negotiations for 2006 contract pricing, but he expected "that instinct will start arising in people this quarter or next quarter."

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He said that when poly prices last rose -- two years ago -- everyone in the industry participated, regardless of whether they were experiencing higher costs or not. "The guys that don't have poly supplies in house will get price increase passed along to them," Gareeb said, noting that customers of those companies will have to accept a lower rate of return. "We are not willing to accept that."

MEMC's sales are expected to increase 10% with earnings growth of 23% this year, according to Wall Street's consensus earnings estimates from Thomson First Call. Next year, sales growth is predicted at 15% with earnings growth of 24%.

The range for 2006 earnings, however, shows a wide degree of variability with eight analysts seeing earnings between $1.18 and $1.56 a share, with the average at $1.36.

The latest rally in MEMC shares was sparked earlier this week by analyst Paul Leming of Soleil Securities Group, who said polysilicon maker

Advanced Silicon Material

plans to sell its external poly exclusively to the solar panel market in 2006, thereby removing 5% of the world's poly supply available to the chip industry.

For Leming, that's another positive for MEMC. He currently holds the highest earnings estimates on Wall Street, and he says it's only a matter of time before the average moves toward his target. Leming's company has no investment banking relationship with MEMC.

The St. Peters, Mo.-based company's stock has been one of

the year's hottest equities, up 50% from $13.25 at the start the year. The gain has corresponded with an aggressive campaign to pay down debt. It also occurred as the company's controlling shareholder has steadily sold shares into public markets, raising trading liquidity and arguably boosting the valuation.

At Friday's closing price of $19.88, the stock trades at 14.6 times next year's expected earnings. Based on Leming's target, the price-to-earnings multiple drops to 12.8.

As the stock has increased this year, its forward P/E has stayed in the 12 to 15 range, indicating that investors still haven't pushed the shares ahead of fundamentals. At a certain level, the stock becomes too pricey, but it's not there yet.