Micron (MU) - Get Report is a remarkable company. Given the challenging market conditions, Micron delivered weaker guidance than the market hoped for, giving short term investors reasons to throw in the towel. But in the bigger picture, there was more than enough for long-term shareholders to feel delighted with its operations.
- Micron is Jim Cramer's Real Money Stock of the Day
- Watch How Micron Trades Before Throwing It Under the Bus
Short-Term Versus Long-Term Shareholders
Fact: short term investors don't compound huge wealth. This quarter's guidance had enough details on the surface to make one's stomach turn.
We see Micron's infamous operating leverage working, with a small drop in its guided Q1 2020 revenue, which is expected to be down 37% year-over-year to $5 billion, fully collapsing its gross margin down by more than 55% year-over-year. In turn, this weighed on its guided bottom line, with its non-GAAP EPS coming down by close to 87% year-over-year. In other words, it was a no good news just around the corner quarter for Micron.
Further down the road, DRAM is expected to improve starting in calendar 2020, while NAND will take a little longer before the environment starts to strengthen. Readers should remember that although NAND's weak pricing has been hitting headlines, NAND actually generates less than a third of Micron's total revenue. DRAM's dynamics are critical to Micron's success, and DRAM fundamentals are expected to start to improve soon.
Number One Takeaway
Investors need to think holistically about Micron and will they be rewarded for it. Micron has stated throughout fiscal 2019 that it would look to deploy at least 50% of its free cash flow towards buybacks.
In actuality, it finished fiscal 2019 not only deploying 65% of its free cash flow towards buybacks, but did so at an average price of $40 -- which is highly rewarding for its long-term shareholders. Thus, all together Micron bought back 7% of its shares.
What's more, even during the cyclical downturn, Micron continues to be expertly operated and delivers some free cash flow (approximately $260 million in Q4 2019), a substantial improvement over previous cyclical downturns Micron has had to navigate.
Valuation - Large Margin Of Safety
As noted, Micron's next quarter's guidance was not what investors wanted to hear. Nevertheless, although the stock sold off after hours and at one point it was down 9% in after-hours trading, it recovered slightly and is now down about 6.7% in Friday morning trading.
Why? Because investors are cognizant that in a fully-priced bull market, there are not many bargain opportunities available that boast of having a large buyback combined with a rock-solid balance sheet ($3.4 billion of net cash).
What kind of multiple are investors presently paying? It is difficult to answer accurately, given the volatile financial performance Micron delivers. However, common sense dictates that in any instance, assuming that Micron is nearing the bottom of the industry slump investors are not being asked to pay more than 8x its normalized free cash flows.
Watch This Number
Micron's DRAM technology is a commoditized product. Accordingly, there is only so much Micron can do when its competitors become too aggressive with their pricing.
Micron noted on the call that its peers were seeking low margin revenue. Hence, Micron with its limited competitive advantages has few realistic options at its disposal aside from opting to walk away from unsatisfactory transactions.
For now, despite the industry slump and competitors' actions, Micron excelled in moving its inventory days down from the 143 days last quarter to 131 days this quarter. Nevertheless, Micron notes that it's long-term normalized inventory target of 100 is not likely to be reached any time soon due to greater processing complexity and the broadening of its product portfolio to high-value solutions.
The Bottom Line
In the short-term, emotional investors are dictating the share price movement with a sell first, ask questions later approach. But in time, rational shareholders will lead the way towards repricing Micron's valuation higher and closer to fair value.
Save 57% During Our Fall Sale. Join Jim Cramer's Action Alerts PLUS investment club to become a smarter investor. Click here to sign up and save!
Michael Wiggins De Oliveira is LONG MU