Bloomberg

Following sizable 2019 gains, Micron's (MU - Get Report) light earnings and gross margin guidance is overshadowing a better-than-expected top-line outlook.

On Thursday afternoon, the memory giant reported August quarter (fiscal fourth quarter) revenue of $4.87 billion (down 42% annually) and non-GAAP EPS of $0.56, topping consensus analyst estimates of $4.59 billion and $0.51. However, the company also guided for November quarter revenue of $4.8 billion to $5.2 billion (down 37% annually at the midpoint) and EPS of $0.39 to $0.53, which compares with consensus estimates of $4.8 billion and $0.53.

Micron's stock fell sharply in after-hours trading and was down 7.4% to $45.01 in early trading on Friday. It had gone into earnings up 53% on the year, after having rallied in response to better-than-feared numbers in June and March. NAND flash memory rival Western Digital's (WDC - Get Report) shares have dropped 2.5% following Micron's report.

Separately, shares of chip equipment makers Applied Materials (AMAT - Get Report) , KLA (KLAC - Get Report) and Lam Research  (LRCX - Get Report) are lower after Micron set a fiscal 2020 (ends in Aug. 2020) capital spending budget of $7 billion to $8 billion, soundly below reported fiscal 2019 capex of $9.11 billion. As it is, chip equipment suppliers have seen their sales to memory makers fall sharply this year amid an industry downturn; demand from other major clients, such as Intel (INTC - Get Report)  and Taiwan Semiconductor (TSM - Get Report) , has often been healthier.

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Gross margin pressures -- caused by memory price declines, product mix changes and slower manufacturing cost declines -- are heavily responsible for Micron's earnings guidance. The company is guiding for a November quarter non-GAAP gross margin of 25% to 28%. That's down from a better-than-expected 30.6% in the August quarter, and well below a year-ago margin of 59%.

NAND and DRAM Trends

Pricing trends for NAND, which accounted for 31% of Micron's August quarter revenue, have begun to improve with the help of stronger demand, as smartphone storage capacities continue growing and lower prices boost attach rates and average capacities for solid-state drives (SSDs). Though its NAND average selling price (ASP) fell by a high-single digit percentage sequentially last quarter, Micron says NAND prices are now starting to increase, and that it's "starting to see supply tightness" in parts of the market.

For the whole of calendar 2019, Micron now expects NAND industry bit demand to grow by a low-to-mid 40s percentage; that's up from a prior outlook for a mid-30s percentage increase. In addition, with capex cuts making themselves felt, Micron now expects roughly 30% industry bit supply growth, down from a prior outlook for a high-30s percentage increase.


Micron's 2019 and 2020 DRAM and NAND industry outlooks. Source: Micron.

The pricing environment for DRAM, which accounted for 64% of last quarter's revenue, remains more challenging for now. Micron's DRAM ASP fell by about 20% sequentially last quarter, matching its May quarter decline. The company also mentioned on its earnings call that it's seeing "aggressive market pricing" in parts of the DRAM market, and is choosing to walk away from some transactions as a result.

Micron is maintaining its guidance for DRAM industry bit demand to grow by a mid-teens percentage in 2019. However, whereas the company previously guided for industry bit supply to grow by a mid-to-high teens percentage, it now only says that industry supply is seen "exceeding demand," without specifying by how much.

On the call, CEO Sanjay Mehrotra noted server and graphics DRAM demand has begun rebounding in the wake of customer inventory corrections, and that smartphone DRAM capacities continue rising. However, he also mentioned sales to China's Huawei are well below where they were expected to be before Huawei was put on the U.S. Entity List in May. Also, Mehrotra indicated some Chinese clients are choosing to stockpile DRAM and NAND inventory amid heightened trade tensions, albeit while stating he thinks this buildup is much smaller than the inventory builds the industry saw during the second half of 2018.

Micron's Upbeat 2020 Forecast

Micron's 2020 outlook for DRAM -- an industry that has mostly consolidated around Micron, Samsung and SK Hynix -- is more encouraging. The company expects "high-teens to 20%" industry bit demand growth, and only mid-teens supply growth. Micron's own supply growth is expected to be "close to market demand."

For NAND, Micron expects bit demand to slow to the "high-20s to low-30% range" in 2020, but also sees supply growth being "somewhat below" demand growth. Notably, Micron expects its own supply growth to be "significantly below the industry," as it leans on the NAND inventories it has built up to help service customers.


Micron's expectations for its own memory supply growth. Source: Micron.

Over the long-term, Micron expects DRAM and NAND bit demand to grow at mid-to-high teens and low-30s compound annual rates, respectively, and for its own supply growth to track with industry demand growth.

Elevated Inventories and a Buyback Pause

Micron's inventories continued growing last quarter, rising 4% sequentially and 42% annually to $5.12 billion. Days of inventory stood at 131 at quarter's end -- down from 143 three months earlier, but still above historical norms and Micron's long-term target of 100 days. A "further decline" in days of inventory is expected for the November quarter.

The company noted on its call that while its DRAM inventory is larger than its NAND inventory in dollars, its days of NAND inventory are a lot higher than its days of DRAM inventory, thanks to a strategic decision to build up NAND inventory ahead of a fiscal 2020 manufacturing technology transition. At the same time, Micron did say that it has "elevated inventory levels" for DRAM chips made using certain older manufacturing process nodes.

Stock buybacks, which slowed sharply during Micron's May quarter, appear to have stopped altogether during its August quarter. In line with comments made three months ago, Micron says it repurchased $2.7 billion worth of shares over the course of fiscal 2019.

However, CFO Dave Zinser did reiterate Micron's goal of spending at least half of its annual free cash flow on stock buybacks. The company produced $4.08 billion in FCF in fiscal 2019, after having produced $9.2 billion in fiscal 2018 amid a memory boom cycle.

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