Micron Technology Inc. (NASDAQ:MU) is exposed to the growth of DRAM and NAND. However, DRAM oversupply will continue to weigh on ASP and MU’s top line. NAND will help in erasing some DRAM woes. Lagging node is also a challenge as it’s resulting in marker share loss. Nonetheless, the stock trades at a substantial discount as oversupply and competition concerns forced investors’ hand for an impetuous sell-off during 2015.
About the company
It’s a memory chip company that designs and develops DRAM, NAND and NOR based memory solutions. The company serves end-market like computing, consumer electronics, networking, automotive, industrial, embedded and mobile. Micron has four reportable segments: compute and networking business unit (CNBU), storage business unit (SBU), mobile business unit (MBU) and embedded business unit (EBU). CNBU provides memory products to compute, networking, graphics and cloud server markets. SBU is involved in the provision of NAND based flash components and SSDs to enterprise, client storage and removable storage markets. MBU cater to the memory needs of the mobile and tablet market. EBU sells memory products into automotive, industrial and connected home end-markets. Micron also markets its products under the brand of Crucial and Lexar. Micron Technology was founded in 1978 and is headquartered in Boise, Idaho.
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- MU 15-Year Financial Data
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Net sales of Micron totaled $16.36 billion during the fiscal year ended 2014, an astounding 80% year-over-year increase. The company generates most of its revenue from the sale of DRAM products. During the nine months ended in June, 65% of the company’s revenue came from DRAM; NAND contributed 32%. Segmentwise, Micron generates most of its revenue from CNBU followed by SBU. CNBU contributed 43% towards the revenue during the first nine months of fiscal 2015. Growth remained under check as DRAM sales shrunk 1.7% during the first nine months of 2015.
First Nine Months Ended FY 2015
DRAM and NAND are set to witness double-digit growth during the coming years. The PC market has been sluggish for some years now, but the shift toward mobile and wearable devices will maintain the DRAM and NAND growth in coming years. According to Micron, bit demand is expected to grow at CAGR of 27% during 2012-2017. However, market’s revenue is expected to grow at CAGR of 13% during 2013-2019 amid lower ASP. NAND market is projected to grow at CAGR of 15% during 2015-2019. Micron will benefit from the growth of the DRAM and NAND as the company generates more than 60% of its revenue from DRAM. Further, revenue mix is shifting towards NAND, which is expected to grow faster than DRAM and has a lower cost per bit. The shift of the mix will boost growth and margin of the company going forward.
PC woes will be offset by the growth of wearable and IoT. Wearable shipments are expected to grow 125%-150% during 2015 and will continue to grow at CAGR of 21% through 2019. M2M and IoT are also taking off. Connected homes will also contribute towards DRAM and NAND growth going forward. According to Micron’s internal projections, DRAM bit demand will grow at CAGR of 23% between 2015 and 2019; NAND will witness a CAGR of 34% during the same period. Note that top line will not grow at the same rate amid supply concerns and a lower ASP.
The company is transitioning towards 20nm DRAM; volume ramp-up is expected by the middle of 2016. Closing the technology gap with Samsung will help Micron stabilize its market share by the end of 2016, and 20nm will also allow Micron to reduce costs and improve margin. Further, new memory technology 3D XPoint holds promise as it’s 1,000 times faster than NAND and 10% denser than conventional DRAM. Wider adoption of the technology can make Micron a leader in the Memory space.
From a valuation perspective, Micron is in a dirt-cheap zone. The stock trades at a forward PE of 7 despite shrinking earnings expectations in fiscal 2016. Standard & Poor's 500 trades at 18 times forward earnings while the industry average stands at above 10. Assuming flat earnings in perpetuity and a discount factor of 9%, Micron is worth more than 50% its current price. Growth is also priced cheaply as PEG stands at 0.39. FCF based on $4.1 billion average CAPEX reveals that the stock is trading 15% below its intrinsic value. CAPEX is expected to be around $5 billion during 2016 but average CAPEX for the company will remain way under $4 billion going forward. Overall, Micron looks like a steal at its current price.
Oversupply will continue to deteriorate Micron’s top line in the short term. Thirty percent supply growth is expected in 2016 while bit demand is set to grow at 25%-27%. Increasing supply will put downward pressure on the average selling price of DRAM. Micron, with a larger portion of revenue from DRAM, will experience shrinking revenue in 2016. Analysts are expecting around 1% year-over-year decline in sales during 2015. Sales are expected to remain flat during 2016. Earnings will decline amid extensive R&D expenditure, 20nm DRAM and 3D XPoint ramp-up. Speaking of which, 3D XPoint is not set for massive adoption in the near term amid cost concerns while the rampup will boost CAPEX and reduce FCF in the near term.
Gartner also expects oversupply in 2016 due to limited new capacity and technology migration. The research firm notes that DRAM revenue will decline 17.4% and 7% during 2016 and 2017, respectively. Morgan Stanley (NYSE:MS) also expects mild DRAM oversupply during 2016. Consequently, ASP will drag Micron’s revenue down.
Micron is playing catchup in node scaling. Samsung is offering 20nm based DRAM that is also cheaply priced. As a result, Micron and others have shed market share recently. Between quarters, Micron’s DRAM market share declined from 23.35% to 22.60%. It will continue to decline until the first half of 2016 as the company ramps up 20nm DRAM. To add to the woes, Samsung is expected to become the major supplier of DRAM for iPhone 6S. Further, technology roadmaps reveal that Samsung will continue to keep its lead in node shrinkage.
To review, oversupply concerns, strong competition, node transition and new technology ramp up will negatively affect the bottom line of Micron during the next year or so.
EVA-based valuation reveals significant upside. See the valuation sheet below. Ten percent p.a. growth in earnings is assumed during 2016-2020 despite a consensus of 15%. No growth is assumed in perpetuity. CAPM is used for cost of equity.
Focus Equity Estimates
The table indicates that MU is extremely undervalued even with relaxed assumptions. And, the company can achieve a 3.4% growth in residual earnings if it remains a going concern. Comparing the perpetual growth with the implied growth derived below also shows undervaluation.
The chart above reveals an astonishing data point. Assuming 10.4% required rate of return, MU’s current market price of $16.59 implies -7.38% long term residual earnings growth. If Micron’s earnings decline around 7% in perpetuity then the current trading price is justified. To the contrary, Micron is set to grow around 3% in perpetuity that translates into a substantial upside as depicted by the EVA valuation. Monte Carlo simulation results are no different.
A Monte Carlo simulation, which applies uncertainty to the inputs of that residual earnings model, predicts a most likely value per share of $24.7, an upside on 56%. The Monte Carlo simulation outputs a distribution of potential values ranging from $4.63 to $49.2 reflecting a wide range of analyst EPS estimates for the coming years. Prudena's models indicate that Micron is undervalued by more than 50%.
Micron is facing several headwinds including both short term and long term. Micron’s DRAM exposure will continue to weigh on the company’s earnings during 2016. Samsung’s aggressive strategy is affecting the whole market including Micron. Lagging node is also adding to Micron’s problems. Earnings’ estimates are already adjusted by the analysts; 16% and 17% decline in EPS is projected by the analysts for 2015 and 2016 respectively. The decline aligns with the DRAM contraction projected by Gartner. Micron will offset some of the decline in DRAM from NAND. NAND sales of the company increased 20% during the first nine month of 2015.
We believe analyst estimates are slightly overdone. MU will be able to beat the analysts and post stock price gains when it reports full-year results in 2015. Going into 2016, upward revision in earnings estimates will be catalytic for stock price growth. Even the consensus earnings result in a cheap PE and PEG. EVA valuation also paints a very favorable picture for Micron. In conclusion, headwinds are already reflected in negative earnings revisions and stock price decline. Oversupply and competition fears provide investors with a compelling entry point to benefit from Micron’s growth. We rate Micron a strong buy.