Micron Still Gets No Respect

Investment Thesis

Micron (MU) is trading at an unprecedented valuation when compared to other stocks in the industry. Management reiterated their confidence in the business at the Citi technology conference on September 6th, where they outlined some amazing progress. Micron’s margins have improved dramatically as has their commitment to returning value to shareholders.

Their investments in improving the business are keeping competitors from gaining on them. We have only grown more bullish as the stock has fallen in price. We have had no choice but to start a position in the stock given the illogical recent declines in price. We fully expect Micron to be a $100 stock within the next decade and think that now is a reasonable time for investors to add to their position or to start a new one.

Background

We recently wrote an article recently about how Micron gets no respect. At the time Micron was trading in the low $50 range. In our view, nothing has changed, Micron is benefiting from improving gross margins, substantial debt reduction, and strong secular trends that their products are the leaders in. The movement to cloud and the need for more data storage, if anything, continues to accelerate. Data is gathered and stored often with multiple backups in order to ensure important information is not lost.

Companies use data for all decision-making, which means more information is tracked, stored, and processed than ever before. Micron’s NAND and DRAM memory products are faster and more durable than other types of memory solutions, which is exactly what cloud companies need to appease their customers. Remember, the need for data is greater than ever before and the need to access this data quickly is only increasing.

Source: YCharts

The stock is falling as metrics are improving

Edward Altman, an NYU STERN professor of Finance created a formula in the 1960s called the Altman Z score. This test is used for manufacturing companies to calculate the risk of bankruptcy. This metric has had a good track record historically. A score below 3 is not good whereas a score below 1.8 is considered very poor. So as an advanced technology manufacturing company, we used this test to assess the current state of Micron.

The stock has gone nowhere in 2018 and has even declined recently. The financial solvency of this company has only improved. Over this period of time, Bearish investors have focused endlessly on the soft patch in NAND and DRAM prices as potential arbiters of Micron’s doom. We disagree wholeheartedly as this company is only getting stronger over time. With an Altman Z score approaching 6, any concerns about Micron’s financial condition appear to be taken off of the table for now.

Source: YCharts

The potential for a legendary stock buyback program

As of the most recent quarterly earnings report in June, Micron’s total shares outstanding have been hovering at around 1.16 billion. We believe that with Micron about to begin returning capital to investors in a big way, Investors should be optimistic about this stock. For investors who have been following Micron for a while, the talk about memory prices being volatile is nothing new. In fact, for the last 5 years, we have primarily seen prices fall dramatically.

Price declines are actually to be expected in the semiconductor space, however, memory prices have been particularly volatile compared to other semiconductor markets. So when macroeconomic news and short-term supply and demand concerns hurt the stock, it creates opportunities for investors to deploy capital for the long term in value stocks like Micron. At the Citi Global Technology Conference on September 6th, Micron CFO Dave Zinsner used some basic math to outline that with their intent to return 50% of free cash flow to shareholders. If you used 2017 income numbers that would total $4 billion according to Dave.

By our calculation, if that return of capital was in the form of a stock buyback, Micron could reduce the number of shares outstanding by ~80 million shares per year, or 6-7% of the total shares outstanding. This calculation would require an average purchase price of around $50 per share, which with current prices would be very reasonable.

Source: YCharts

Micron will continue research and development without Intel

In July of 2018, Micron and Intel announced that their joint venture for the research and development of 3D XPoint memory technology would conclude in 2019. 3D XPoint is a non-volatile memory (NVM) technology by Intel and Micron Technology; it was announced in July 2015, and have been available on the open market under brand names Optane (Intel) and QuantX (Micron) since 2017.

To simplify the purpose of the technology as much as possible, it fills a gap in the market between NAND and DRAM that was not previously addressed directly in the market. Intel and Micron formed their joint venture for this purpose and will continue their own future product development independently of each other in the future. In our view, Investors should expect Intel to become a larger player in the memory space over time.

Source: CNET.com

A rising tide of cash and value

As mentioned previously, Micron’s value and financial strength have been steadily increasing over time. Cash and equivalents on the balance sheet have risen to all-time highs passing $8 billion in February as the company has become enormously profitable. With over $10 in EPS expected for 2019, we can buy the stock for just about 4X 2019 expectations, keeping in mind that these expectations have started to come down in the last few weeks amid DRAM and NAND oversupply concerns.

Source: YCharts

Conclusion

Micron is expected to announce earnings next week on Thursday, September 20th. We are hopeful that management will continue to paint a strong picture for the opportunities in the business. With the recent decline in the stock, due to worries about oversupply in the market, Investors have the right to be cautious. However, for long-term investors, who do not need to hit quarterly performance targets the way that professional investment managers do, the stock is a clear value opportunity in a sea of high-flying stocks.

We still believe that Micron is a compelling value play that will capitalize on powerful trends in technology over the long term. We have been bullish on the stock for a while and with the intense selloff, we just recently initiated a position with an average purchase price of $41.79 per share. We think it is reasonable to expect more pressure on the stock in the short term. Our prediction is that this stock will trade above $60 over the next 18 months.

Disclosure: I am/we are long MU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.