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Backed by the improving memory market conditions, stable prices and the first full quarter of Elpida financials, Micron Technology’s (NASDAQ:MU) Q1 2014 earnings surged by 120% year over year and net income increased to $358 million, compared to a net loss of $275 million in Q1 2013. While overall NAND flash revenue grew by 8%, on account of an improving demand-supply balance, the inclusion of Elpida’s earnings contributed to a 69% sequential rise in Micron’s DRAM business. Though DRAM pricing was flat, trade NAND pricing declined by 6% quarter over quarter, due to ample supply.

Macro weakness, the demand-supply imbalance, intense competition and declining selling prices lowered all Micron’s top line growth and impacted its profitability in 2012. However, increasing consolidation in the industry, rising demand from non-PC markets, and improving memory product prices returned Micron to profitability (net income $1.2 billion) in fiscal 2013. The company started fiscal 2014 on a strong note and expects the positive growth momentum to continue for the rest of the year.

Micron claims that the industry fundamentals for both DRAM & NAND products remain solid, and it is getting strong demand signals from a majority of its customers. With a large and diverse memory product portfolio across a number of end-market segments, and the second largest installed manufacturing capacity, Micron is in a strong position to benefit from the improving industry dynamics.

Our price estimate of $15 for Micron is at a 30% discount to the current market price of $21. We are in the process of updating our valuation.

Significant Reduction in Inventory To Improve Memory Market Dynamics

Excess manufacturing capacity, combined with soft market demand, lowered the profitability of memory products in 2012. However, the industry consolidation in 2013 improved the demand-supply balance considerably. With manufacturers holding back supply and improving macro environment fueling demand, the market dynamics in the industry are improving.

DRAM – The fire at Hynix Wuxi fab last fall resulted in significant reduction in inventory across the DRAM supply chain, in particular for the PC and mobile segments. Micron believes that the inventory situation will decline further in subsequent quarters, which combined with balanced long-term production and demand, will drive growth in the DRAM market.

Like other market players, Micron is focusing on leveraging its existing technology road map to deliver more advanced devices to its customers. Capital spending in the DRAM market in the last few years has been more focused on technology migration rather than on building new wafer manufacturing capacity. More advanced tools are swapped into existing production lines to manufacture devices at finer geometries. Micron estimates the DRAM industry wafer production to be down by 5% in 2014, with total DRAM industry bit supply up in the mid-20% range. Because of its ongoing DRAM to NAND conversion, the company estimates its DRAM bit production growth to be in the mid-teens, below the industry level for 2014 (calendar year). It expects industry capacity to remain relatively stable beyond 2014, and looks forward to the return of higher bit demand growth and greater profitably, both of which are still below the long-term average.

NAND – In the NAND space, a significant portion of the capital spend by Micron is being utilized for transitioning the additional fab capacity from DRAM to NAND. In addition, the company is investing even more in building greenfield cleanroom floor space and an early pilot line for 3D NAND.

Micron projects NAND industry supply growth in the low 40% range for 2014 (calendar year), which includes a 10% growth in industry wafer production and the remaining supply growth coming from technology transitions. Micron’s total NAND supply growth was below the industry in 2013 but it expects the same to be slightly above the industry in 2014, as it shifts additional DRAM capacity to NAND. The company continues to focus on targeting higher value NAND devices for specific customer applications, and sees a more favorable supply and demand balance going forward.

In sum, with both the DRAM and NAND businesses, the company anticipates greater stability, a sharp contrast to the dramatic cyclicality that affects both from time to time

Acquisition Of Elpida Fuels Micron’s DRAM Business

Over the last 18 months, Micron has increased its manufacturing capacity by over 90% (without adding to industry capacity) through acquisitions and redefining strategic joint venture partnerships. With the acquisition of Elpida, Micron was estimated to have the second largest installed capacity, which better equips the company to service large customers.

Micron closed its acquisition of Elpida in July 2013. In addition to acquiring 100% of Elpida’s equity, Micron also gained control of 24% share of Rexchip Electronics Corp. from Powerchip Technology and some of its affiliates. Together with Rexchip shares acquired from Powerchip, Micron now controls approximately 89% of Rexchip’s outstanding shares and 100% of its product supply.

Samsung (OTC:SSNLF) and SK Hynix (OTC:HXSCF) were the top two players in the DRAM market with shares of 37% and 26%, respectively. However, as per research firm IDC, Micron and Elpida together account for 28% of the market, making Micron the second largest DRAM player behind Samsung.

In addition to becoming the second largest DRAM manufacturer, the acquisition of Elpida expands Micron’s footprint in the mobile DRAM market, the fastest growing DRAM segment. Though Micron is the leader in enterprise DRAM solutions for networking and servers, it historically generated less than 10% of its revenue from mobile DRAM. The addition of Micron’s legacy mobile business with Elpida’s mobile business comprised roughly 30% of Micron’s DRAM revenue in Q1 2014.

Q2 2014 Outlook

- DRAM production bit growth and quarter-to-date ASP to be flat. DRAM cost per bit to decline by high single digit.

- NAND production bit growth in high teens, quarter-to-date ASP to be down high teens and cost per bit down mid-teens.

- NOR revenue in the range of $100 – $110 million.

Disclosure: No positions

Source: Micron Reports A Solid Q1'14