The share price of Micron (MU) has roughly tripled since the end of 2012. Has the valuation gone too far too fast? My analysis suggests that the answer is "yes."
Part of the reason for the increase in the valuation is the closing of the Elpida acquisition. That said, I think memory prices have increased recently and could decline in the coming quarters. Also, Micron isn't consistently profitable. The industry consolidation should improve profitability, but I would prefer to take a "wait-and-see" approach. The memory market is commodity-like, and the prices and volumes are volatile. Thus, while industry consolidation should improve supplier pricing power, I'm not sure that it will make Micron a consistently profitable company.
Additionally, customers still have significant bargaining power. At this point, I can't justify getting long shares of Micron after they have tripled in a year. I may consider getting long on a pullback. But, that depends on what the industry looks like following the closing of the acquisition. Lastly, the acquisition, cash flows and dividend policy make it hard to value Micron. Consequently, I would need to find valuation metrics that work well for this company.
For now, I'm neutral on shares of Micron, but could use a pullback to get long.
- Micron announced that it is shipping 2GB Hybrid Memory Cube ("HMC") engineering samples. HMC is designed for applications requiring high-bandwidth access to memory. Micron expects HMC to migrate to consumer applications within three to five years.
- Micron announced that its 16-nanometer NAND process technology was chosen by Flash Memory Summit as the 2013 Best of Show award winner in the category of Most Innovative Flash Memory Technology. Micron's 128Gb multilevel cell ("MLC") NAND Flash memory devices are targeted at consumer SSDs, removable storage (USB drives and Flash cards), tablets, ultra-thin devices, mobile handsets and data center cloud storage. They provide the greatest number of bits per square millimeter and the lowest cost of any MLC device in existence. In fact, the new technology could create nearly 6TB of storage on a single wafer.
- Micron announced the closing of the acquisition of Elpida's equity and the completion of its acquisition of a 24 percent share of Rexchip Electronics Corporation. The acquisitions increase Micron's current manufacturing capacity of 300mm wafers by 45 percent. Micron will increase its presence in the mobile phone and tablet markets.
In terms of competition, there were three key suppliers of the DRAM market at the end of the third quarter of 2012. Samsung (OTC:SSNLF) controlled the largest shares of the market with 41.9%. SK Hynix controlled 23.8% of the DRAM market, and Micron and Elpida combined to control 24.8% of the market. In the NAND flash market, Samsung was the largest supplier with Toshiba second, Micron third and SK Hynix fourth.
I consider SK Hynix to be the best peer company comparison, but there are issues with the disclosures from Hynix. Specifically, there is limited disclosure from the company, which means I wouldn't have much confidence in the analysis. With that in mind, I will analyze the performance of Micron without using a peer company comparison.
Micron is a solid top-line growth story with exceptional cash flow from operations generation growth. The bottom line is hit or miss with a net loss of $1.03 billion in 2012. But, the 5-year shareholders' equity CAGR is respectable. The acquisition of Elpida gives Micron a much needed boost to productive capacity.
Also, the acquisition consolidates the industry, which should boost profitability. Micron is in need of a profitability boost. Overall, the financial performance paints a bullish picture, but I would like to see improved profitability through a less volatile gross margin. Given the debt level, it may be a long time before management is able to enter a less commoditized industry.
The ASPs and volumes of DRAM and NAND are volatile, which impacts revenue and gross margin. Recently, revenue has been increasing on higher ASPs and volumes. So, I think revenue may be closer to a high than a low. Of course, I could be wrong and revenue could continue to rise. That said, based on the revenue dynamics, it is probably better to get long Micron after a decline in ASPs and/or volumes. Next, I'll take a look at the valuations of the company to see what they add to the analysis.
I'm going to use a residual income model and multiplier models to value the common equity shares of Micron. Micron doesn't pay a dividend and its free cash flows are volatile; thus, I don't consider a dividend discount model or free cash flow model appropriate. In terms of the multiplier models, I'm going to use a momentum valuation and the method of comparables.
The residual income model is simple in this case: Micron isn't generating a return on equity, and the firm is losing money. Consequently, the residual income model would suggest a neutral or bearish position.
The momentum valuation also suggests a neutral or bearish position. Micron has tripled in value since the end of 2012. The share price is near its recent peak valuation and is near its 2006 high. So, this probably isn't a good point to be getting long shares of Micron.
Compared to its 5-year average valuations, Micron is overvalued. The current price/book and price/sales valuations are more than twice as high as the five-year averages. Also, the price/cash flow valuation is about four times the 5-year average. These valuations are unadjusted. The company recently acquired Elpida which lessens the ability to use these valuations.
In conclusion, all three valuations methods suggest being neutral or bearish on shares of Micron. Given the economic climate, I'm not going to consider short selling Micron. Consequently, I'm neutral on shares of Micron.