I'm a big fan of unloved stocks. When the entire investment community has soured on a struggling company, its shares can fall so far below any sort of intrinsic value, that a shift to "less bad" news could trigger a huge relief rally.
As an example, I was singing the praises of Micron Technology (NYSE: MU) back in early December when shares traded below book value. They're up 25% since then, as investors have started to see things as half-full rather than half-empty. I still think another 25% to 35% gain lies ahead.
More recently, I've been focusing on another unloved tech stock. It's so unloved, that it has fallen from a peak of $80 in late 2007 to a current $3.90. That's a 95% drop. This stock will never, ever again see $80 (at least in my lifetime), but could easily be back at $7 or $8 in 12-18 months.
I'm talking about MEMC Electronic Materials (NYSE: WFR), which once ran a solid, though cyclical, business of providing silicon wafers used in the manufacture of semiconductors. It's a capital-intensive business, capable of throwing off solid cash flow when industry conditions are aligned.
But management grew restless in the middle of the last decade and tried to migrate the company beyond its roots into the hot field of clean energy. Well, at least it was a hot field back in 2007 when this stock was at $80. The foray into clean energy (the company provides the raw material for solar panels, but also builds solar-powered projects) has been an unmitigated disaster. MEMC has spent hundreds of millions, and is now trying to salvage a broken business.
How ill-advised was the whole venture into solar power? MEMC just took a $1.4 billion write-down to impair the value of a range of assets. It's been a very long time since I've seen a company take a write-off of that magnitude.
Part of that write-down also involves the traditional semiconductor business, which has been delivering subpar sales and margins as well. Management is sharply cutting production capacity in all aspects of its business. Similar moves are afoot elsewhere in the industry. For example, poly-silicon production, which is what MEMC and rivals produce to make semiconductor and solar panel wafers, is being cut by 30% in China.
…Which is precisely why I'm focusing on this stock right now. Reduced supply helps cut the losses, and demand may soon turn up. MEMC notes that orders from key semiconductor customers appear to be bottoming in the current quarter, with indications of an upturn in demand in the next quarter.
And though the move into clean energy was a mistake, MEMC's SunEdison division, which develops large-scale power-generation projects, is healthier than the solar industry headlines would imply. SunEdison has been securing a range of long-term contracts for its power output, so it's been generating modestly positive cash flow. The company is currently bidding on roughly 3 Gigawatts (GW) of power contracts, which would be valued at roughly $10 billion.
Analysts say the combination of lower costs and modestly improving revenue should help MEMC move back to profitability. Specifically, they anticipate the company will lose money in the next two quarters, but swing to a profit in the second half of 2012 and make roughly $0.50 a share in 2013.
I'm assuming they're wrong and profit growth will be much more muted. But I also think this is where profits are headed by 2014, perhaps even closer to $0.75 a share. This implies 5% net profit margins by 2014, or around $160 million in net profits. As a point of reference, the semiconductor wafer business generated an average of 27% net margins in 2004 through 2008. Assuming MEMC gets back to 10% net margins, which is likely a best-case scenario, then the division would throw off roughly $1.50 in earnings per share. Not bad for a sub-$4 stock. The solar power business: I'm assuming it just becomes a break-even business because costs have been lowered and industry pricing conditions should soon bottom out.
Risks to Consider: Shares may languish in the near-term because the company is expected to remain unprofitable for at least another quarter. Expectations that the semiconductor segment will rebound may prove off the mark if Europe enters into a protracted economic contraction.
Action to Take --> Most analysts have taken a wait-and-see attitude toward the impact of MEMC's move to sharply cut costs and capacity. Price targets typically range from $3 to $7, though Citigroup sees shares rising to $10, or roughly 10 times their projected 2013 earnings forecast of $0.94 per share. I personally don't see the company's profits reaching that level before 2014 or 2015, but I think Citigroup is correct in identifying the potential scale of a profit rebound, whenever it comes.
Though I don't think we'll be seeing Citigroup's $10 price target reached any time soon, a move up to $7.50, or nearly 100% above current levels, could be the likely target as this company finally exits a five-year losing streak that has expunged more than 95% of the value of this stock.