The semiconductor industry is cyclical, meaning that the revenue and earnings of companies operating in this industry can be very seasonal. A skilled management team, therefore, is required to ride these waves and generate sustainable profits in the long run.
The Covid-19 pandemic has made things even worse for the industry as East Asian countries, including China, went into a two-month-long lockdown, which saw manufacturing plants being shut down to curb the spread of the virus. Micron Technology, Inc. (MU, Financial) reported fourth-quarter 2019 earnings on March 25 that saw a year-over-year revenue decline of approximately 18%.
However, because of recent changes the company has made, led by CEO Sanjay Mehrotra, I believe Micron has the firm footing to weather the storm and deliver value to shareholders.
A world-class response
Micron operates some of its assembly plants in China, so the company has been exposed to the pandemic for well over two months now. In preparation for an eventual spread of the virus on a global scale, the company implemented several initiatives in January to ensure the smooth running of business operations even in a worst-case scenario:
- The company handed out protective gear to employees across all its production sites in Asia on Jan. 3.
- Asian factories were divided into two groups: the red team and the blue team. Social distancing measures were implemented to separate the two teams to minimize the probability of a company-wide shutdown resulting from critical employees contracting the virus.
- Back-up remote-operating centers were established at all its factories.
- The important raw materials required to continue production, such as silicon wafers and industrial chemicals, were purchased in bulk and kept in store as a precautionary measure.
- All the safety measures taken in Asia have been implemented at U.S. facilities as well, even though the industry has not seen a massive disruption yet.
- A bonus check of $1,000 would be given to all U.S. employees earning less than $100,000 per annum.
The company is already reaping the benefits of this preparedness. For example, many U.S. chipmakers are pushing the state and federal governments to classify semiconductor production as an essential service, and Micron is leading the charge by pointing out its success in Asia. In Malaysia, similar efforts reaped the desired rewards in March, primarily because of the social distancing policies implemented by semiconductor companies, including Micron.
A stay-at-home economy will lead to a surge in demand
Work-from-home policies are enacted by many companies across the world, with no exception in the United States. A few states have already asked their residents to stay indoors, and the chances of a nation-wide lockdown are very real. Even after the spread of the virus is contained, many companies would likely still want some of their employees working remotely as they realize the cost benefits associated with such a decision. Therefore, it would be a mistake to classify this as a completely short-term phenomenon. Rather, distance working could become the new normal for parts of corporate America. E-commerce store operators such as Amazon have already been identified as clear winners of this trend. However, many investors and analysts are turning a blind eye on chipmakers who would be at the center of this change.
First, faster internet speeds would be required to facilitate millions of people to work from home. The Federal Communications Commission (FCC) announced on April 1 that they are working toward passing a bill to allow Wi-Fi devices to access a wider swath of airwaves in a bid to boost internet speeds in the United States. FCC Chairman Ajit Pai said on Wednesday:
“By doing this, we would effectively increase the amount of spectrum available for Wi-Fi almost by a factor of five. This would be a huge benefit to consumers and innovators across the nation.”
If this policy is enacted, faster speeds would be available as early as the second half of this year, according to the statement. To facilitate this leap, telecommunication companies would have to improve their technological infrastructure, which would lead to a surge in demand for chips. In addition, smartphone and personal computer manufacturers would be forced to buy new chips to support higher speeds, once again resulting in robust demand for the semiconductor industry.
Second, an increase in the number of smart devices sold worldwide can be expected as professionals will look to improve their home offices to embrace the new changes to their work life. This, in return, will result in personal computer manufacturers such as Dell and HP buying more semiconductors from Micron and other industry-leading chipmakers.
Third, the demand for cloud computing services is expected to grow exponentially in the next couple of years. Even in the absence of Covid-19, things were looking good from this front. The outbreak of the virus accelerates the speed at which companies across the world are embracing cloud storage and computing, as it is critical to facilitate remote working. According to the fourth-quarter filings of the company, this segment accounted for approximately 16% of company revenue. The contribution, however, can be expected to increase in the future as Micron will focus on ramping up the production of chips required to enable more transitions to cloud platforms.
Even though Micron would not immediately emerge as a winner of the stay-at-home economy, the company will likely report substantial earnings growth as a result of this development.
The semiconductor industry plays a role in the fight against Covid-19
The virus has now spread to more than 200 countries. In January, many believed the virus would not spread outside of China. However, the United States has now become the epicenter of the pandemic with over 220,000 reported cases as of April 2.
Leading biotechnology companies are in a race to develop a vaccine to cure the novel coronavirus. In their bid to find a treatment, all these health care giants are using advance technological capabilities. An uptick in the demand for medical equipment is certain, and this is good news for chipmakers as they supply the necessary components required for the accurate functioning of many medical applications.
On the other hand, telemedicine companies are reporting a record level of demand for their services as well. For instance, the Wall Street Journal reported on April 2 that many companies cannot keep up with the demand, even though most of these companies were finding it difficult to grow their business in the recent past. Hospitals across the United States are prioritizing Covid-19 patients, and the partial lockdown of the country has made it difficult for people suffering from other medical conditions to seek medical care. Telemedicine companies are capitalizing on this opportunity. Teladoc Health, Inc. (TDOC, Financial), the largest stand-alone service provider in the U.S., reported a 50% increase in consultations for the week ended March 20. The company and privately-owned peers such as Doctor on Demand are looking at increasing capacity by installing more servers to address this situation. This is good news for Micron and the semiconductor industry, as high-performance chips are essential to facilitate such an expansion.
Takeaway: the recent drop in Micron shares creates an opportunity
The broad market decline punished Micron as well, even though the company is in a good position to benefit from the pandemic.
Source: GuruFocus
In January, Micron announced a plan to curb the production of smartphone chips to allocate more resources to manufacture cloud computing chips, which will likely pay off in the coming months as the majority of the world stays indoors to contain the spread of the virus. Wall Street analysts have a median target price of $63.60 for Micron shares, which is approximately 55% higher than the market price of around $41 on Friday. A convergence with this estimate can occur as soon as the fourth quarter of this year as the company is likely to report higher-than-expected earnings.
The company is on firm footing as a result of its preparedness, to which the credit should be given to the prudent management team led by the CEO. Had Micron’s manufacturing plants been forced to shut down in Asia in the last couple of months, the company would have found it difficult to match the increased demand for its products. This goes on to highlight why Warren Buffett (Trades, Portfolio) is a big fan of investing in companies with visionary leaders. The guru famously said, “Predicting rain doesn’t count. Building arks does.”
Micron, in every sense of the word, has been building arks in the last couple of months in anticipation of a global spread of the virus, and the company is now looking set to reap the rewards.
Disclosure: I own Micron shares.
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