Memory chip manufacturers must be agile and have robust inventories to ensure they are ready for economic shocks. Although Micron Technology (MU, Financial) did well during the Covid-19 pandemic and resulting chip supply shortages, it has faced a drop in demand since then, and its lack of agility has been revealed to investors.
The Covid-19 pandemic has had a profound impact on the semiconductor industry. The shortage of raw materials and skilled labor, higher freight costs and delayed deliveries have all taken their toll. However, there has been one silver lining: the increased demand for smartphones, TVs and other electronic devices has helped to sustain the industry. The increased demand for microchips has allowed the industry to weather the storm well.
However, growth is slowing down due to macroeconomic factors and a supply glut as supply chain issues begin resolving. Micron is among those companies that are feeling the squeeze. The company faces challenges on many fronts, including lower product demand and increased competition from rivals. As a result, Micron's stock price has dropped sharply in recent months.
Despite these challenges, Micron remains a leader in the semiconductor industry, and its products are in high demand. However, it remains to be seen how well the company can weather the current storm.
Micron is facing cyclical changes
Micron Technology is facing several challenges that will likely weigh on the company in the near term. Firstly, demand for personal computers has declined over the years as consumers increasingly turn to mobile devices such as tablets and smartphones. This has led to weaker-than-expected demand for Micron's main product, DRAM chips. Secondly, the company is also facing headwinds from a stronger U.S. dollar, which has made its products more expensive in overseas markets and decreased the value of international sales. Lastly, Micron is currently transitioning to newer technologies, which has led to higher research and development costs.
Unlike competitors, Micron focuses solely on memory chips and does not venture into the logical chips market. The company mainly derives revenues from its DRAM and NAND memory chips, which account for over 90% of its revenue. The singular focus has advantages, but Micron takes a big hit every time the demand for memory chips lowers.
Currently, the market has an overflow of memory chips; it will take at least another quarter for the supply and demand to match. In other words, Micron is facing a supply glut. A supply chain crisis triggered by the global pandemic led to governments honing in on the chip shortage. This emergency-driven government investment resulted in an overshot.
Recent earnings
Micron's struggles came to light when it reported earnings recently. The company posted a 20% decline in its fiscal fourth quarter revenue to $6.6 billion, mainly due to rapidly weakening consumer demand. The annual revenue, though, jumped 11% to $30.8 billion. Most major business units saw a double-digit decline year-over-year in the fourth quarter.
On the bright side, the company posted a $1.6 billion profit during the fourth quarter. The company also declared an 11.5 cents per share dividend and bought back shares worth $784 million during the quarter.
In response to weakening demand, Micron has decided to cut its wafer starts by 20% to address the excessive production and avoid a price war in the industry. The chipmaker also plans on cutting its capital expenditures during the current quarter. Investors take this as a sign of weakness, which is why the announcements have sent the stock downward.
Micron is playing the US-China trade tensions to its advantage
On a brighter note, Micron has opportunities to benefit from the U.S.-China trade tensions. The company plans to invest in building new plants in the U.S. due to governement financial incentives. There will be an element of risk associated with this course of action; after all, there are plenty of well-documented reasons as to why manufacturers moved out of the U.S. to begin with, first and foremost being the fact that the labor is expensive. However, Micron's pivot toward the American market could help protect it from future geopolitical tensions.
The U.S. sanctions on China to reduce sales of semiconductor technology and manufacturing machinery to the country will have a two-way effect. It's like shooting your opponent in the foot, but in return you have to also shoot yourself in the foot. The long term impact of these actions is yet to be seen, but I believe Micron may benefit from this in the short term. China's YMTC is one of its main competitors, and its business will be negatively affected by U.S. sanctions. YMTC acquires materials worth up to $2.5 billion annually from Lam Research (LRCX, Financial), a semiconductor technology provider. Thus, YMTC is among the dozens of companies that will be directly affected by sanctions, as it will no longer be able to buy its manufacturing equipment from Lam, giving Micron a leg up.
Micron plans to invest a total of $100 billion in a plant in New York over the next 20 years. It will create about 50,000 new jobs and help boost the local supply of semiconductors. The company also plans to invest $15 billion through the decade's end in a facility in Boise, Idaho. The moves come soon after the U.S. government passed the CHIPS and Science Act, which will see $50 billion spent on revitalizing local semiconductor production.
Takeaway
The bottom line is that Micron is in trouble in the near term. It is expected to take a financial beating in the next few quarters due to excess inventory and a lack of sales momentum. Micron needs to find a way to sell its chips at a lower price, or it needs to find a way to increase its sales momentum. Lowering the price means compromising on margins. But that might be what it needs to do to combat the supply glut.
However, Micron's problems are not unique, and many other companies face similar issues. Micron's stock price reflects the headwinds it is facing at this time, and the stock is down close to 40% this year. In the long term, it can likely recover, but a lot hinges on whether semiconductor manufacturing can be successfully and efficiently brought back to the U.S.
