RealMoney Silver - Clock's Running Out on DRAM's Good Times

Clock's Running Out on DRAM's Good Times
By Bob Faulkner
RealMoney Contributor
9/28/2007 2:01 PM EDT

DRAM manufacturers are about to run out of good news -- in about 60 days or so. Without a big surge in demand really soon, we probably won't see a reason to own these stocks and will have to wait until next July for some positive indicators.

Micron's (MU) stock popped 6% Thursday on positive comments by a sell-side analyst who suggested that, in his opinion, the company may surprise to the upside when it reports next Tuesday. The catalyst, from his perspective, will be NAND flash.

While it is true that contract prices for the popular multilevel cell parts have increased in the 23%-25% neighborhood over the course of the company quarter, they have also dropped 8%-11% since the quarter closed.

Despite the price increase during the quarter, NAND flash represents only about 25% of the company's revenue. And about half of the output is from the IM/Flash joint venture with Intel (INTC) and not subject to the price increase.

The real catalyst for Micron's quarter will be commodity DRAM prices, and today's Wall Street Journal article about Hynix speaks volumes about conditions in that market. According to the article, Hynix has stopped selling DRAM in the open market during the past month, and is only fulfilling its contractual obligations to OEMs. Obviously, pricing has declined below Hynix's cash or variable cost whereby it makes more sense not to manufacture because you lose less money.

Historically, the DRAM market has a seasonality to it driven by the back-to-school season and the holidays. As OEMs ramp production for the second half, prices of these commodities tend to start rising in the June-July time frame and generally stay fairly strong into late November. Last year, that strength continued on through year-end, in part due to the shift of some capacity from DRAM production to NAND flash production by large manufacturers.

As you can see from the chart below, the industry experienced that classic move up in pricing on cue in July. But the firming dissipated in August and has been weak since then. Looked at from a different perspective, most DRAM OEMs expect prices to decline on average between 30% and 40% on a year-over-year basis. The current average declines for the 512 Mb parts are running between 50% and 60%.

Contract prices are heavily influenced directionally by spot market prices over time. Despite Hynix having removed its capacity from the spot market, spot prices have continued to remain quite weak (hence softening contract prices). This suggests substantial excess capacity or weak demand.

On the demand side, there has been nothing to suggest anything but positive near-term results. Both Hewlett-Packard (HPQ) and Dell (DELL) reported solid results and Intel recently raised its guidance. While no one can rule out a negative surprise from AMD (AMD) , that will be more the result of being in Intel's crosshairs than a market issue.

So that leaves the supply side of the equation. I have discussed in this forum before the issue that the semiconductor capital equipment industry in 2005 and 2006 was driven by very strong demand from memory manufacturers. Initially, it was NAND-driven, but in the latter stages shifted over to DRAM. That capacity is apparently not fully absorbed yet, and we're seeing the results with current pricing.

Unless there's a dramatic change in demand over the very near term, the seasonally strong period will end in about 60 days or so. Then you'll have to wait until next July for some positive indicators.