- MU is benefiting from an unseasonably strong supply/demand situation.
- Beneficial Inotera accounting as well as the R&D tax credit should add to profits.
- It was the 2nd best performer in the S&P 500 in 2013, up 243%. Year-to-date it's up 14.7%.
- Given current catalysts and a strong industry environment, I expect to see $35 within the year.
Last month I wrote about 5 lesser-known Micron (NASDAQ:MU) catalysts for 2014. Today, I'd like to talk about some near-term catalysts for Micron, some of which have gone unnoticed by sell-side analysts.
Windows XP End-Of-Life
After April 8th, Microsoft (NASDAQ:MSFT) will no longer support Windows XP. This doesn't sound like a very meaningful event since it was originally released in 2001, but surprisingly, 29% of computers still run the antiquated operating system. XP's end-of-life will mean an end to nearly all technical support, which makes it an increasingly easy target for malware. 20% of North American and European corporate computers are running XP, and Forrester Research estimates that only 6% of those will be running XP by the time April 8th rolls around. Certainly any corporations or government agencies that have the budget to upgrade will do so to avoid the lax security that has caused other companies problems, like Target (NYSE:TGT).
I asked a computer salesman friend of mine how many businesses he's dealt with that are looking to migrate from Windows XP, and his reply was that the businesses had already begun the upgrade process, and that he was now dealing with individuals with older systems who had been given that extra incentive to go shopping. Regardless of whether you're talking about individuals, corporations or government agencies, XP's obsolescence means not just new business for Microsoft, but a resurgence in the computer business during what is normally a seasonally slow period. A computer from 2001 or shortly thereafter simply isn't modern enough to have Windows 7 or 8 installed on it, and must be replaced completely. This should keep ASPs strong for both DRAM and NAND.
Bonus statistic: 95% of the US's 420,000 ATMs run XP, and will take longer to upgrade.
To be honest, despite being bullish on Micron, I thought that DRAM prices would be on a gradual decline by now, with both Christmas and Chinese New Year over with. I'm pleased to say I was wrong. Of course spot prices are of limited use these days, but they are still an acceptable rough gauge for the strength of the memory industry, and the DXI is still sitting around its high.
Not only are the holidays over, but an event that many analysts had viewed with much trepidation has come to pass - Hynix (OTC:HXSCF) now claims that it is producing wafers at normal speed in its fire-damaged fab in Wuxi. From its January 28th conference call:
"First, the Wuxi fab has returned to normal as of November in terms of wafer in, and today it has returned to normal in terms of wafer out as well."
It had been widely assumed that prices couldn't help but decline after the Wuxi fab returned to normal, so how is it that there's been no apparent effect? Manufacturers will have to re-qualify the chips being produced, and yields are almost certainly below average. More importantly, inventory is low and will take time to fill again, and by the time it fills demand will again be ramping back up. Also from the conference call:
"The DRAM market usually experiences seasonally low demand in the first quarter, but for this year, demand is expected to keep increasing for PC and server products as clients try to build up inventory to make up for the generally low inventory level in the market following the tight supply in the previous quarter."
Part of what will ramp demand will be the introduction of new key products. One such is Samsung's (OTC:SSNLF) upcoming flagship smartphone, the Galaxy S5, which will be revealed on February 24th at Mobile World Congress. The "Prime" version of the phone is expected to include a 2560x1440 screen, fingerprint sensor, 3GB of DRAM, and at least 32GB of NAND. That's 50% more DRAM than Samsung's previous flagship phone, and double the minimum level of NAND. In addition to this being a boon for the memory industry, I expect the phone to benefit RF Micro Devices (RFMD) due to its high level of RF content, as I recently wrote.
On September 4th, Hynix's Wuxi fab had a fire that put 100,000 monthly wafer production capacity of DRAM out of commission. That's about 10% of worldwide capacity. To compensate for this, Hynix transferred capacity at M11 and M12 in Korea from NAND to DRAM. Wuxi is now operating normally again. From the recent Hynix conference call:
"In addition, the part of NAND capacity used for DRAM production will be reverted to NAND in the first quarter."
That means that the repairs in Wuxi are effectively raising NAND production, not DRAM production. Simultaneously, Samsung is transitioning wafers to NAND that it had temporarily moved to DRAM, and Micron is in the process of migrating 60,000 wafers in Singapore from DRAM to NAND. This will serve to keep DRAM capacity tight while raising NAND capacity. This is important for two reasons:
Micron got 69% of revenue from DRAM this past quarter.
DRAM has relatively inelastic demand, while NAND has elastic demand. In other words, it doesn't matter what the price of DRAM is, you want about the same amount. 4GB is a typical amount for a personal computer, 2 GB is a typical amount for a high-end smartphone. That's the amount that it takes to make them work effectively. Significantly less would be too slow, and significantly more would be unnecessary. NAND, however, has an effectively limitless demand. It serves as the storage in your SSD or mobile device, and more storage is always better, if the price is right. As you lower the price, the demand rises. By transitioning some production of DRAM to NAND, the industry is able to keep DRAM prices high without much hurting NAND prices.
Micron owns about 35.5% of Taiwanese DRAM manufacturer Inotera. Last year it was receiving about 95% of production from the company and paying market price minus a certain value for the chips, meaning that as prices rose, Inotera's gross margin rose while Micron's did not (though its equity investment in Inotera benefited.) Micron renegotiated this deal, and starting last month, receives 100% of production. More importantly, it now gets profit sharing. As a result, Inotera's gross margin is dropping from 53% to an expected 45% +/- 3%. That extra 8% is going to Micron, starting next quarter. From Micron's CFO Ron Foster at the recent analyst day:
"Okay. So the question was about the Inotera agreements and we renegotiated those. We actually set in place a three-year agreement but it has provisions to revisit some of those terms annually. This was the first year we started, January 2013 with that arrangement and so we had a review and reassessment of that being the first year of our arrangement. We did as they also committed and have some adjustments that were built into that structure. And those went into effect January 1st. It's basically an ASP - for those of you who don't know it's a market minus or ASP minus pricing model that has some adjusters based upon their profitability.
And so that has an effect as we go into this calendar year. As I mentioned on the earnings call, it will not have an effect in our fiscal second quarter because there is a three month averaging period and lag effect that go on that will ship that out in time. And of course it always depends upon the prices in effect, in DRAM and how they're moving overtime, how that calculus works. But that's what's going on. Most of that was put in place at the beginning. We tweaked it, if you will in this latest cycle and we have the opportunity, to your question, to address it every year as part of that agreement and then renew the agreement fairly straight forward and automatically over time. So that's something that we'll be looking at each year as we come to the renewal of that activity."
R&D Tax Credit
The impact of the R&D Tax Credit was introduced to me by Seeking Alpha Contributor Retired Securities Attorney.
Since 1981, the IRS has allowed corporate tax credits for research and development, which has saved firms more than $12 billion a year. Although it has been extended 14 times (sometimes retroactively) and is supported by both parties, it has recently expired. Not only is it likely to be renewed, legal rulings may also broaden it. From the Washington Post:
"Currently, the IRS forbids companies from claiming tax breaks for costs associated with experimental products they ultimately sell. But after losing a number of recent lawsuits, the Treasury Department proposed last fall to let firms claim the credit for prototypes of new products, even when the companies are able to sell the prototypes themselves to their customers. Any tax benefits under the new rules would be retroactive, permitting firms to reduce tax bills dating back years."
If it's renewed there would be a larger one-time gain in the quarter it's renewed in, followed by smaller ongoing gains.
In addition to a healthier environment for memory thanks to greatly reduced competition, I expect Micron to benefit from a variety of near-term catalysts. I expect to see over $35 a share within the year.
Disclosure: I am long MU, RFMD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.