Micron Has a Good Long-Term Story That's Trading on the Cheap

The chipmaker is a highly compelling investment despite poor short-term visibility after the current quarter.
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Micron  (MU) - Get Report was one of the first large U.S. companies to report in the coronavirus environment on Wednesday after the close.

It is led by a very strong management team focused on increasing shareholder returns. although it's plagued by poor near-term visibility after the current quarter, its fiscal third quarter. Nonetheless, too much negativity is already priced into this stock, with shares down more than 20% this past month (including the recent recovery). Right now is a terrific bargain opportunity to consider Micron.

Very Noisy Guidance

Micron has a leading position in the memory and storage industry, with strong secular tailwinds to its back. However, given the current coronavirus outbreak, it has very poor visibility into operations past fiscal Q3 2020, as its operations are lagging indicators into the sector. Put another way, customers' purchases this quarter and next had already been contracted out previously. 

Micron's exposure to key verticals are as follows:

  • ~ 27% to servers
  • ~25% mobile phones
  • ~20% PCs
  • ~20% automotive, includes industrials and other applications

In our present work-from-home environment, Micron's customers have increased demand for storage solutions in the cloud, and employees and students have increased their demands for home and enterprise notebooks, hence there is some pull into this quarter's performance. 

At the same time, though, phone manufacturers have significantly slowed down production in the face of logistic disruptions and consumer confidence decline, as many consumers lose their jobs and we enter a global recession.

Accordingly, it offered very choppy guidance ahead, as Micron's near-term performance is uncertain, even by Micron's standards.

What About Its Long-Term Potential?

Demand for storage and memory solutions are only going to increase over time.  As consumers and businesses continue to consume content and data, the demand for storage will provide a very long secular tailwind for Micron.

Furthermore, although Micron has some cyclical elements, in time, the present cycle will be less pronounced than previous memory cycle downturns of the 2000s and recently witnessed in 2016.

Demand for 5G capable smartphones, servers, cloud, automotive industry, consumer electronics, gaming, and IoT (Internet of Things), are not going to suddenly taper off.

As a reminder, Micron derives close to 65% of its total revenue from its DRAM segment. DRAM is faster, denser and more expensive. But given the number of gigabytes per dollar it stores, DRAM becomes fairly inexpensive for companies that require extensive storage solutions.

DRAM is manufactured by just three companies globally. Consequently, even though it is a commodity product, it is still able to command huge premiums.

When Will Micron's Cycle Turn?

It often feels that Micron's upcycle is expected just around the corner, however, it never seems to quite arrive. Currently, Micron is having to navigate a global recession brought about by the coronavirus outbreak. 

Having said that, Micron's fiscal Q3 2020 is pointing at the midpoint (of a very wide guidance range) towards $4.9 billion in revenues. This would imply that year-over-year its revenue would be down 16%.

However, sequentially, this would drive a very small improvement from Q2 2020. Presently, I believe that investors are grasping with optimism for any positive news coming out from companies that do not have to reduce operations amidst the coronavirus outbreak.

On the other hand, Micron noted several times throughout its investor call that the company is a lagging indicator, meaning that a drop in consumer confidence globally has not yet been reflected in its outlook.

Does This Mean That Fiscal Q4 Will Be Challenging For Micron?

This certainly appears to be the case. Micron notes that many customers are now buying memory components in bulk to avoid any possible logistic disruptions, creating a surge in demand. 

However, as companies stockpile inventories, this will imply that down the road, there will be an overabundance, which will depress future sales for Micron, possibly starting with Q4 2020.

Valuation - Huge Upside Potential

I contend that Micron is worth a $90 billion market cap versus $50 billion presently, or at least 60% higher.

1) The demand for memory in servers, cloud, 5G, machine learning, and autonomous vehicles is only going to increase, it is not going down. Thus, there is a very strong secular tailwind to its operations.

2) During this downturn, Micron is still expected to be profitable, which is a vastly improved situation compared the last downturn of 2016.

3) Given a more normalized environment such as it had in 2018-2019, with steady DRAM prices, Micron could return to making $9 billion of free cash flow. Without any heroics, this company could trade on a 10x to FCF (not earnings, but clean free cash flow, which is valued significantly higher).

I fail to see how these aspects combined should not command a 10x multiple to normalized free cash flow.

The Bottom Line

Although Micron's fiscal Q3 2020 is looking reasonable, Q4 2020 may well come out suboptimal relative to previous expectations that Micron would be starting to upswing into the memory cycle.

However, I continue to believe that long-term, Micron will deliver strong returns to shareholders, once we get past the coronavirus pandemic. 

Disclosure: The author holds a long position in Micron