The global semiconductor market is forecasted to reach $676 billion in 2022 according to Gartner, which represents an increase of 13.6% from 2021. This is driven by a higher average selling price (ASP) from the global chip shortage and application tailwinds. More specifically, the DRAM (Dynamic Random Access Memory) market is projected to grow by 22.8% and the NAND market is expected to grow by 38.1%.
Micron Technology (MU, Financial) is the fourth-largest semiconductor company in the world and a leading provider of DRAM and NAND. Thus, one would expect this stock to be the perfect way to play the upcoming growth in 5G, computing and data centers.
Legendary value investor Mohnish Pabrai (Trades, Portfolio) even added more to his holding in the stock in the fourth quarter of 2021 according to his firm's 13F report. In a recent interview with me on my value investing YouTube channel Motivation2Invest, Pabrai spoke highly of the company and stated the memory business is like a “30% tax on data centers."
However, Micron's stock price has fallen by 42% since March and 22% since June. Why is Micron selling off despite the positive outlook for the sector? Let's take a look.
Strong earnings, poor guidance
Part of the decline can be attributed to the forward guidance that Micron issued when it reported earnings results for its third quarter of fiscal 2022.
Micron generated strong earnings for its fiscal third quarter. It achieved revenue of $8.64 billion, up 16% from the $7.42 billion achieved in the same period last year. This growth was driven by data center revenue, which was up by 50% year over year. Mobile revenue declined slightly year over year, but was up over the prior quarter.
Total operating income was $3 billion in the third quarter, up 36% from $2.3 billion generated in the same period of last year.
The company expects 5G unit sales to grow and reach approximately 50% penetration of the smartphone unit total addressable market this year, which is a significant tailwind.
Non-GAAP earnings per share were $2.59, which was higher than the analyst consensus prediction of $2.44 per share. Operating cash flow was $3.84 billion, up 7.8% from $3.56 billion in the same period of last year.
However, Micron’s management produced weak guidance moving forward. According to the CEO Sanjay Mehrotra, “Recently, the industry demand environment has weakened, and we are taking action to moderate our supply growth in fiscal 2023.”
The Non-GAAP earnings are forecasted to be between $1.43 and $1.83 per share in the fiscal fourth quarter, which is lower than the conesus analyst estimate of $2.62 per share.
The company annouced that they will take "immediate action" to reduce supply growth trajectory. Micron has plans to use excess inventory this year to supply "part of the market demand next year." While the company stressed this is just expected to be a short-term downturn, investors are still upset.
Analyst downgrades
Wall Street didn’t take management's outlook lightly, and there were multiple downgrades by analysts. Piper Sandler downgraded the stock to a Sell rating. In addition, Summit Insights analyst Kinngai Chan downgraded the stock to a Hold. Chan stated, “Our recent industry checks also indicate elevated memory inventories at Asian brokers, module houses and original design manufacturers... Industry checks indicate persistently sluggish demand from smartphone customers and a continued decline in PC client demand."
Chan believes Micron may have to reduce its prices due to the low demand. Fears are that this will impact its gross margin. The macroeconomic environment of high inflation, rising energy costs and rising interest rates also doesn’t help the situation. High energy costs increase input costs for businesses and household costs for the consumer. Rising interest rates increase the cost for companies to service debt and consumers to make mortgage payments. The end result is less surplus income for the consumer and less spending on technology gadgets such as smartphones, PCs, wearable devices, etc.
Micron is a leading supplier of DRAM and RAM memory and has over 50% exposure to consumer markets such as PC and mobile, which means these concerns are nothing to sneeze at.
The good news
The good news is that the long-term secular trade of the increasing number of technology devices, 5G and data centers is still strong. The global 5G services market is forecasted to reach a staggering $1.67 trillion by 2030 according to Grand View Research, growing at a 52% CAGR between 2022 and 2030.
5G cell phones are an especially interesting tailwind for Micron, as 5G devices have 50% higher DRAM and double the NAND content versus 4G phones, according to Juniper Research.
Micron’s CEO also is optimistic on the long term outlook:
“We are confident about the long-term secular demand for memory and storage and are well positioned to deliver strong cross-cycle financial performance.”
Valuation
In order to value Micron, I have plugged the latest financials into my advanced valuation model, which uses the discounted cash flow method of valuation.
For my previous valuation a few months back I forecasted an optimistic 20% revenue growth rate per year for the next five years. However, due to the headwinds and lower guidance, I have slashed my revenue growth rate estimate to just 5% per year. This is very conservative, but I believe that is the best method to value a stock in a bear market.
Given these conservative assumptions, I get a fair value estimate of $89 per share for Micron stock. The stock is currently trading at ~$53 per share. Thus, it is more than 40% undervalued. This represents a significant margin of safety at the current price.
The GF Value chart, a unique intrinsic value model from GuruFocus, rates the stock as significantly undervalued.
Final thoughts
Micron Technology is a tremendous company and one of the top players in DRAM. The long-term secular tailwinds in 5G and cloud data centers offer a tremendous opportunity for growth. While I do believe the industry will see lower demand in the short-term and thus the stock will be volatile, it is currently undervalued based on my own valuation model and the GF Value model and thus could be a great long-term investment.
