Micron (MU) - Get Report is fast approaching what appears to be the bottom of its cycle. Yet, even as it navigates this extraordinarily challenging period, the chipmaker continues to generate free cash flow.

And for now at least, Micron's valuation is still very much in the bargain basement.

Q2 2019 - Beats All The Way

On the surface, Micron beat on both top and bottom line. But on deeper analysis, some troubling questions are bubbling.

The most pressing of these is that despite management's rhetoric that there are early signs of demand, inventory continues to pile at an alarming rate. At the end of the Q3 2019, Micron's inventory figure stood at 149 days. That number is not only a huge jump from the previous quarter, but is practically 50% higher than at any point during the past 10 years. 

With this number in mind, Micron's management has had little choice but to cut back capex for 2020. This will increase the amount of free cash flow available, but it also means that the industry is still very much oversupplied.

Repurchases Came In Weak

The next aspect which investors should be mindful of is that Micron's share repurchases during Q3 2019 amounted to a dismal $157 million at an average cost of $39.25 per share. By comparison, Micron's management deployed a massive $2.5 billion for repurchases during the first half of its fiscal year. Once again, contrary to what management has been saying, Micron's management is clearly not feeling overly confident that the bottom of the cycle is close at hand.

Outlook - More Questions Than Answers

Micron's earnings call was even more lacking in color than usual. As a reminder, Micron derives close to 65% of its revenue from its DRAM memory. This where the focus needs to be on. As soon as DRAM's outlook strengthens, investors' positive sentiment will also return.

The one tangible aspect that could be derived from Micron's earnings call was that Micron's outlook for DRAM demand appears to be stronger for the second half of calendar 2019 when compared with the first half.

Despite this outlook, Micron's management felt it prudent to reduce capex in 2020. Just how much, at present it is difficult to say. However, the capex reduction is a significant move because it signals to Micron's competitors that Micron is acting rationally and that hopefully Samsung (SSNLF)  and Hynix (HXSCL)  will follow suit.

Finally, it's worth noting that Micron's Q4 2019 adjusted midpoint EPS is expected to come in at approximately $0.45. Does this mean that Q4 2019 is close to the bottom of the memory pricing cycle? At the moment, it is difficult to say for sure. What we can clearly point to is that this figure is unquestionably better than many analysts had been expecting, with some penciling in for EPS numbers for Q4 as low as $0.17.

Year to date, Micron has spent 70% of its free cash flow on share repurchases. This quarter it came in below that figure, but they are committed to putting 50% of their annual cash flow towards repurchases until they reach $10 billion for buybacks in total.

Valuation - Unquestionably Cheap

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The table above highlights the fact that not only is Micron trading at a discount to its peers, but also at a meaningful discount relative to itself.

The last few weeks have been a very interesting experience for Micron shareholders. Any mention of China (of any sort) and Micron would sell off. Then, when trade-war discussions started to recede, Micron did not benefit on the upside.

Evidently, investors were gloomy beyond reason. But as the table highlights, all that negativity, plus a lot more, has already been priced in. Remember, Micron's balance sheet continues to be rock solid, finishing Q3 2019 with approximately $3 billion of net cash and equivalents.

The Bottom Line

If Micron continues to post positive figures and allocate more than 50% of its free cash flow towards share repurchases, investors just need to sit tight for a little longer.

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Michael Wiggins De Oliveira is long MU