Micron: Time to Get Defensive?

The bull thesis on Micron (MU, Financial) was based on the premise of analysts’ fear regarding Micron’s business cycle. Most of Micron watchers were unable to see that the industry has evolved due to proliferation of connected devices. The cautious approach of analysts in forecasting Micron’s earnings helped the company beat estimates, leading to stock price appreciation.

Positive revisions in analyst estimates followed, boosting the stock price even further. The stock is up an impressive 51% since my last piece on Micron that elaborated on Micron’s ability to add material gains.

Is there more upside?

This is the key question now. Myriad positive developments have moved the stock up during the past month, making it necessary to revise the fundamental valuation aspect of Micron. But, first, let’s explore what has happened in the past few weeks.

Impressive quarter

The company managed to beat earnings consensus during its fourth-quarter of 2017. Fourth quarter EPS was around $2.02, beating analyst estimates by around 8%.

Stellar performance was supported by growth of unit-sales and ASP of both DRAM and NAND. DRAM sales grew 5% during the year while NAND sales were up 3%. ASPs grew 8% and 5% for DRAM and NAND, respectively.

In line with the super cycle thesis, the company guided for a mid-point revenue and EPS of $6.3 billion and $2.16, respectively, comprehensively beating analysts’ forward consensus. The stock was up around 4% due to impressive earnings results.

Positive analyst sentiment

Naturally, analysts revised their earnings estimates and price targets. Well Fargo raised the price target to $45, an increase of 12.5% over its previous target. But the analysts at Well Fargo were cautious, as their EPS estimate was lower for 2019 than 2018 amid cyclical fears. They were, however, quick to point out that EPS estimates will be raised if the super cycle continues. Baird and Susquehanna also raised their price target for Micron. The stock was up around 5.5% amid analyst reaction to earnings. KeyBanc’s comments about stable DRAM pricing also nudged Micron in an upward direction.

Recently, CLSA was skeptical about Micron given DRAM supply concerns. They cited addition of 30K wpm in DRAM capacity at Line 16 in Q2 2018 by Samsung (SSNLF, Financial) to put downward pressure on DRAM pricing, which will have a negative impact of Micron and SK Hnynix (HXSCL, Financial). However, JPMorgan defended Micron, citing that DRAM pricing pressure will be offset by tight supply and higher ASP for NAND. Note that Micron generated more than 30% of its revenue from NAND during the fourth quarter of 2017.

Hedge fund manager David Tepper (Trades, Portfolio) is extremely optimistic about Micron and thinks the stock can still increase two to threefold. Comments of Tepper should be taken with a bit of skepticism, though, as his hedge fund Appaloosa Management has about 10% of Micron in its long portfolio.

To review, earnings performance, analysts' earnings revision and overwhelming positive analyst sentiment helped Micron’s recent bullish run in the stock market. However, future stock performance should be tied to the fundamentals and institutional involvement.

What about fundamentals?

Industry prospects look good as the memory market is expected to grow at CAGR of 7.3% during 2016 to 2021, according to IC insights. Specifically, non-volatile NAND market is set to grow roughly 10% p.a.from 2016 to 2022. Statista also forecasts the DRAM market to grow at 5.7% p.a. from 2016 to 2021. All in all, growth is in the cards, which can certainly benefit Micron.

The problem is that growth and analysts’ expectations may already be priced completely in the stock; Micron trended upwards during the past few months as favorable developments unfolded. Let’s see the valuation impact of earnings revisions on Micron.

EVA valuation

Assumptions

• Earnings are expected to grow at 7% annually from 2018 to 2023.
• No growth is assumed in perpetuity.
• Cost of equity is assumed to grow in line with earnings growth.
• CAPM is used to calculate cost of equity.

For valuation purposes, 2017 earnings were used as a base case and industry growth is proxy for earnings growth as analyst estimates vary significantly. See the chart below:

Focus Equity Estimates

Valuation reveals that the stock is slightly undervalued. This valuation takes into account the long-term growth of the memory industry; short-term fluctuations in price can happen. Moreover, a decline is not expected in the industry until 2019, which indicates that the stock can go up during 2018.

Institutional involvement

However, as the stock is trading around its fair value, involvement of institutional investors is a key consideration for investment decisions. Note that institutional investors hold more than 89% of Micron’s stock. Further, the sentiment is quite positive on the sell-side, which shields Micron from downward movements.

Final thoughts

Although Micron is trading around its fair value, selling the stock doesn’t make sense as institutional holding will keep volatility in check while sell-side sentiment will push to drive the price upwards. Nonetheless, Micron is no more in value territory; it’s in momentum.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.