Micron: Market Reacts After Stellar Earnings

Micron (MU, Financial) reported results of its second quarter 2018 at market close on Thursday, once again beating the revenue and earnings consensus.

The company posted revenue of $7.35 billion, translating into 58.1% year-over-year growth. Analysts were looking for a revenue figure around $7.28 billion. Earnings per share more than doubled on a year-over-year basis to reach $2.82 during the second quarter of 2018. Analysts were modeling a non-GAAP earnings per share of $2.74.

Micron is guiding for mid-point revenue of $7.4 billion for the next quarter, which is slightly ahead of analyst consensus of $7.29 billion. The company expects its non-GAAP earnings per share to reach $2.83 (mid-point guidance) during the third quarter of 2018, which is ahead of analyst consensus of $2.66.

Despite stellar earnings and strong forward guidance, the market is reacting negatively with the stock down around 5% in pre-market trading on Friday. Let’s look at the drivers of Micron’s performance during the quarter.

Revenue Insights

Revenue continues to climb, thanks to stable average selling prices and increasing market share. During the first half of Micron’s fiscal 2018, revenue grew 64.2% year over year to reach $14.15 billion. The company cited increased demand across products and markets as the drivers of revenue during the second quarter of 2018. Specifically, revenue growth was supported by mobile business, which registered record growth during the quarter. Revenue from SSD grew 80% on a year-over-year basis with SSD sales to cloud and enterprise tripling during the quarter.

Source: Earnings Transcript Q2 2018

Regarding the business units, computer and networking generated $3.7 billion, up 93% on a year-over-year basis; cloud revenue was up 30% sequentially. The company registered record growth in its mobile business unit with revenue growing 45% on a year over year basis. The embedded business unit, which includes automotive related revenue, increased 41% yea-over-year to reach $829 million. The storage business unit, which includes revenue from SSDs, grew 20% year-over-year to reach $1.3 billion. Overall, Micron posted strong growth across business units.

Source: Earnings Transcript Q2 2018

It can be seen that DRAM captured most of the revenue of the company followed by NAND. Revenue from DRAM increased 76% on a year-over-year basis while NAND revenue was up 28% over the same period. However, NAND revenue declined 3% sequentially. Growth in DRAM revenue was supported by low double-digit growth in ASP along with single digit growth in quantities shipped. On the NAND side, sequential revenue decline was due to decreased NAND ASP.

Earnings insights

Micron managed to increase its non-GAAP earnings per share to $5.27 during the first half of 2018. Most of the increase in earnings growth was primarily because of the revenue growth detailed above. However, the increase in margins also boosted the company’s earnings. During the second quarter, gross margin was up to 58.5% as compared to 38.5% during the same period last year. Operating margin also increased to 49% as compared to 25% on a year-over-year basis.

What’s the outlook?

Demand for DRAM and NAND products along with growing ASPs for DRAM allowed Micron to post yet another stellar quarter. This trend is expected to continue given the super cycle Micron is in. You can read all about the super cycle thesis here. Moreover, pricing outlook is expected to remain positive during 2018. I am obligated to rehash Gartner’s outlook amid current negative reaction of the market.

“DRAM revenue will hit a new high of $65.6 billion in 2017 as the continuing undersupply allowed DRAM vendors to increase pricing. The undersupply will last through 2018, allowing further revenue gains, before a supply-induced downturn in 2019 as vendors add capacity and China enters the DRAM market.”

It seems that Micron will continue to post revenue and earnings growth given the demand of memory across industries that range from computing and cloud to mobile and internet of things. Undersupply of DRAM will continue in 2018. ASPs will, therefore, remain consistent during 2018. There is no point in selling a company that is consistently beating earnings estimates. The sell-off is overdone.

Valuation update

The valuation that follows is an update of the previous valuation and incorporates the updated forecast based on second quarter earnings and third quarter guidance.

Assumptions:

Earnings are expected to grow at 0% annually from 2019 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. GAAP earnings are used for valuation purposes.

Focus Equity Estimates

Economic value added valuation reveals an upside of around 42%. Further, the updated model reflects an increase of 7% in price target as compared to previous model due to revised assumptions.

Bottom line

Micron continues to beat analyst estimates, and it looks like it will continue to do so as analysts and investors remain cautious. The cautious behavior is reflected in the sell-off following yesterday’s earnings. However, as there are no apparent supply problems in 2018, the next two quarters should be smooth for Micron. Moreover, the stock is priced cheaply as can be seen from the EVA valuation above; the price-earnings ratio is also below 10. From an investor's perspective the verdict is: buy the dip.

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