Micron’s costs are going up: here’s why I’m buying anyway
I am the proud owner of Micronic technology (NASDAQ: MU), but this is not a store for the faint of heart. Despite good long-term growth prospects for memory demand, Micron is trading at a huge discount to the market and especially to other tech stocks, even to its peers in the volatile semiconductor industry. This is because of the historically high cyclicality of memory activity, which is prone to ups and downs.
Case in point: Micron’s recent earnings report, in which the company posted stellar numbers across the board, while also giving solid indications. Yet, as always, investors have chosen to focus on the negative, real or perceived. Here is what these concerns are and why I would be a buyer of this drop despite them.
Costs and investments are increasing this year and next year
Memory outages tend to occur when the industry over-invests in supply when demand is good and memory prices rise, to have too much capacity when demand hits an air pocket and recedes. Right now we’re in the early stages of one of those good times. In the last quarter, Micron’s revenue jumped 19% quarter-over-quarter and 36% year-over-year. Adjusted (non-GAAP) earnings per share nearly doubled quarter over quarter. Management predicted that growth would continue into the next quarter, forecasting sequential revenue growth of 10.5% and sequential earnings growth of 22.3%.
Still, on the ensuing conference call, Micron explained that costs would increase more than the market could have predicted. First, the company announced that it was ready to deploy Extreme Ultraviolet (EUV) technology in its DRAM production starting in 2024. But due to EUV supply constraints, Micron has to make advance prepayments. to secure these expensive machines.
Second, while Micron is reducing costs through node transitions, it is also targeting more specialized and higher-value types of memory solutions, but these come with higher costs. The concern here is that Micron will produce more expensive chips in 2022, a time when some believe memory prices could drop.
The fact that Micron only repurchased $ 150 million of shares in the last quarter, or only about 10% of its free cash flow, below the company’s long-term target of 50%, may have -be added to worry. This could indicate that Micron is cautious about its track record for whatever reason.
Why am i not worried
Given not one but several surprising wrinkles in the company’s spending plans, then it’s no wonder that Micron investors – already a fearful group – sold the stock, which is down by around 20% from its April highs.
Still, I think these concerns are a bit exaggerated. Yes, the costs of the UVU are coming sooner than expected, but Micron said its investments this year will grow from around $ 9 billion to over $ 9.5 billion. Micron has over $ 9.8 billion in cash, and it’s likely to be very profitable for at least the next couple of quarters, so it should be able to afford those hundreds of millions of advance payments.
Second, while the costs of the higher-value chips are, well, higher, Micron should still be able to earn as good or better margins on these products, at least compared to the lower-cost chips. After all, there is a reason why management is targeting higher value solutions. Higher value chips may also be less prone to price drops than more commodity-like memory chips. Zinsner noted during the conference call, “we are trying to move towards higher value products, which arguably on a comparable basis – or at least on a comparable basis to other products would generate better gross margins. “.
Finally on share buybacks, Zinser also told investors not to worry:
I think you will find in the fourth [fiscal] fiscal quarter that our redemptions are significantly higher than our fiscal third quarter. So nothing to read there, we think this price is obviously a good price to buy back the stock. And we are committing to what we talked about previously, which is to return at least 50% of our free cash flow in the form of redemptions.
Micron’s share price is now lower than it was for much of the fiscal third quarter ending in May, making buybacks more attractive, so maybe that was just good timing. from management.
Another possibility is that Micron has set liquidity targets in the low end of 30% of its revenue. Therefore, while Micron expects strong revenue growth this year and next, it may have wanted to strengthen its balance sheet to follow its internal model. Micron ended last quarter with $ 12.3 billion in cash and headed for $ 8.2 billion in revenue next quarter, roughly an execution rate of around $ 33 billion. However, Micron has a habit of being cautious and if revenues continue to grow, Micron should have added cash to its balance sheet. Management still expects to use 50% of cash flow to fund buybacks over the long term.
Things aren’t that bad – in fact, they’re really good
While nervous Micron investors tend to wring their hands at any imperfection, some may be unaware of how good conditions are for the memory industry right now. CEO Sanjay Mehrotra has noted the tight supply in almost all of Micron’s end markets, and sees this persist at least until 2022.
This is due to a great combination of pandemic fueled digitization across many industries, a strong economic recovery, and customers looking to maintain higher inventory levels going forward. Many companies such as car manufacturers used to keep the bare minimum of chips in stock in order to reduce capital costs; However, this ultra-lean posture is costing these companies lost sales today.
Combined with the fact that chips are becoming increasingly difficult to produce and the three major DRAM makers have been cautious with the growth in supply, it is easy to see how supply may struggle to catch up with demand. for a certain time.
The latest slowdown was caused by the trade war between the United States and China, which caused a recession-like demand shock in the memory industry, as all customers pulled back to buy at the same. time. While a demand shock like this can happen again, it might not happen anytime soon, or it might not be as severe. It could make this memory upcycle cycle stronger and more durable than some people imagine. If so, then Micron is still woefully undervalued.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.