Contest: Micron at Tangible Book Value and Poised for Growth

Company description and history

Micron Technology Inc. (MU, Financial) is a large-cap company formed in 1978 and based in Boise, Idaho. It produces semiconductor devices, Dynamic Random-Access Memory (DRAM), NAND flash memory and solid-state drives.

It is one of the three main producers of DRAM and NAND; Samsung (XKRX:005930, Financial), SK Hynix (XKRX:000660, Financial) and Micron, of which Micron is the only American competitor. These three companies essentially form an oligopoly, limiting competition and controlling over 95% of worldwide DRAM production and 100% NAND production. DRAM is used in many devices today, including cell phones, computers, servers, tablets, wearables, medical equipment and cars, so it is not a big surprise that about 65% of the company's revenue comes from DRAM. The remaining revenue comes from NAND memory, so the pricing of both is important.

Introductory stats

• Current share price: $31
• Market cap: $35 billion
• Price-to-Tangible-Book: 1.07
• Price-earnings ratio: 2.64
• Price-sales ratio: 1.25

Financial strength

With the current share price trading pennies away from book value, a potential investor might think that Micron is in the beginning stages of financial decline or even a potential "value trap." As one looks closer, it becomes evident this is simply not the case. To start, let’s look at the current financial situation by using the "Big 5" to make sure it is above the 10% growth minimum guideline. Using GuruFocus data below, I give the average 10-year and five-year to illustrate the acceleration of growth.

Not only does Micron pass the 10% growth metric, but the growth has accelerated in the past five years. The earnings per share and free cash flow growth percentages look ridiculously high, but the reason is simply that the earnings went from a negative -$2.35 in 2009 to a positive $11.50 in 2018 and the cash flow went from 90 cents to $6.93 in the same timeframe.

Debt and management

In August of 2016, Micron had $5 billion debt. As of the end of 2018, that debt is gone and the company is sitting on $3 billion net cash. This could help with riding out a potential pricing storm. Micron offers no dividend, yet a large share repurchase program was initiated to bring value back to their investors.

Regarding management, Sanjay Mehrotra has served as CEO since 2016, going from $5 billion in debt to $3 billion in net cash in two years, which is a good sign. It should also be noted the increase in operating margin during his tenure from 2016 to 2018 went from 1.86 to 49.11 respectively. Admittedly, much of the margin increase was due to the 2016 DRAM price drop caused by Samsung overproduction, but it could also suggest that the DRAM oligopoly is now functioning as it should, under Mehrotra’s leadership, keeping a better balance between supply and demand. Only the future will tell how consistent Micron’s growth will be under his leadership, but if past performance is an indication of future results, then the future there is bright.

Valuation

The bullets below are the basic valuation approaches utilizing tools provided by GuruFocus.

• Using the discounted cash flow (earnings-based) model, Micron's price of $31 offers a 76% margin of safety with the fair value of $129.
• Using the discounted cash flow (FCF-based) model, Micron's price of $31 offers a 60% margin of safety with the fair value of $78.
• When Mr. Market “overreacts” negatively, it can be useful to compare the history of price-earnings, price-sales and price-book (medium and low ranges) to get a sense of where it stands relative to its history. The most effective metric to use depends on the industry. For this "cyclical" semiconductor industry, it could be argued that price-sales is the most appropriate. Regardless, I will illustrate all three and let you be the judge.
  • Price-earnings: Using past low and medium averages of price-earnings ratios over the past 10 years, Micron’s share price is approaching its minimum of 2.4 and is 71% under its median level (shown below).

• Price-sales: Using past low and medium averages of price-sales ratios for the past five years, Micron is 40% under its median value (shown below).

• Price-book: Using past low and medium averages of price-book ratios for the past five years, Micron is only 50% under its median (shown below).

Risks

The risks with this company and industry are as follows (listed from most impactful to least). The list below excludes black swan events.

1. DRAM pricing takes a nosedive due to overproduction and competitive pricing. Since Samsung, SK Hynix and Micron form an oligopoly, controlling 95% of the world’s DRAM production, it would not benefit any of them to enter into this competitive scenario.
2. Weak demand would also affect pricing severely, but with analysts estimating a 20% growth rate for the next five years, coupled with the existing and emerging markets; cloud computing, internet of things, artificial intelligence and autonomous driving…weak demand is not likely.
3. China elects to produce its own DRAM. This would weaken the oligopoly, but would be very difficult to pull off successfully while keeping up with new technologies. Very low probability.
4. The trade war with China could shift market share toward Samsung and SK Hynix due to pricing and tariff imposed on Micron.
5. A delayed or slowed adoption of 5G technology infrastructure due to potentially imposed foreign rules, regulations and standards would also delay payback time for investors.

Moat

The moats that protect this company are listed below from the strongest to weakest.

1. The oligopoly (Samsung, SK Hynix and Micron) forms an extremely resilient moat, as it controls 95% of DRAM and 100% NAND memory production for the world.
2. Top performing, cutting edge memory technology. New tech products; 3D XPoint, 64-layer 3D NAND, etc.
3. Brand name and effective management.

Short-term outlook

Micron is followed very closely by many investors and traders. Its cyclical nature is often debated and is considered by some to be more like a commodity, since average sale price (ASP) for DRAM and NAND vary greatly. With the current price today ($31) pennies away from its tangible book value, it is hard to imagine the price going much lower. The short-term sentiment among traders (not investors) is currently negative, with several traders predicting the share price will reach the mid-20’s. I don’t claim to have such skill in predicting the future, so I won’t agree or disagree. While I wouldn’t be surprised if it does reach the mid-20’s, I will only say that with the share price of $31, the short-term upside appears to be much larger than the potential downside.

Long-term outlook

Coming up with the long-term outlook is the fun part of investing because, when it is used with insight, knowledge and understanding of the market, it provides us with an edge to greater returns in the end. Giving an outlook also allows the investor (and/or writer) to speculate (daydream) about what the future might look like if their analysis is correct. That being said, I will try to subdue my enthusiasm for this exciting market, and not go into what advances in our lifestyle will result from 5G technology, Internet of things, Artificial Intelligence, big data and autonomous driving. I will not describe the visions of "The Jetsons" or "Meet the Robinsons" in my outlook, but instead will paint an outlook picture that uses only broad strokes.

One can’t deny that we now live in a digital world, where connectivity, data processing and communication technologies are growing very quickly. The infrastructure for 5G will gradually be built and, with that, the markets and innovations dependent on fast memory technologies will emerge. Micron, one of the three companies that provides this tech, is drastically undervalued. While this future may come slower than analysts anticipate, it will come. When it does, Micron and its investors will be poised and ready.