Micron - Right Reasons To Buy And The 3-D Myth

Mar.19.14 | About: Micron Technology (MU)

Summary

Micron generates its revenue from four reportable segments including DRAM, NAND, NOR and others.

The increased capacity, due to acquisitions, and repaid growth in handheld devices and servers have been the saving grace of Micron.

We also explore the myth that Micron is a good 3D stock.

Micron Technology (NASDAQ:MU) is a specialized semiconductor company that is involved in the production of DRAM, NAND and NOR based memory and storage solutions. We recently initiated coverage with a buy rating which was then followed by an upgrade in price target to $35. The buy recommendation is based on the favorable demand supply conditions for micron, the cost/bit reduction and the growth of the smartphone and tablet industry. This report is an update on the result of the Q1 fiscal 2014 and other events investors should keep an eye on.

Recent Financial and Operational highlights:

The company generates its revenue from four reportable segments including DRAM, NAND, NOR and others. DRAM is the primary revenue generating segment followed by NAND. The company generated around 69% of the revenue from DRAM business in the first quarter of fiscal 2014.

Figure 1 Source: Company's Quarterly results

The chart shows that the DRAM business grew at a faster rate than other segment thereby increasing its share of total revenue. The DRAM sales grew by 69% as compared to the 17% sales growth of NAND. The DRAM growth was supported by growing mobile market along with the improving average selling price.

Revenues:

The company posted revenue of $4.04 billion which translates to a 42% growth sequentially. The revenue grew by more than 100% when compared to the same quarter last year. Micron has benefited from the recent DRAM price surge and a decline in overall supply of the DRAM. The figure below presents the revenue trend of the company.

Figure 2 Source: Financial statements and yahoo finance

Revenue is showing consistent quarterly growth, and this is translating to an annual growth. The company is expected to post a CAGR of 35% during (2013-2015). This is a very healthy growth rate, and we believe that this growth will be reflected in the valuations.

On the earnings front, the EPS declined from a $1.51 in the previous quarter to $0.30 in the recent quarter. However, the EPS is not comparable because of one off gains recognized in connection with the Elpida transaction. The adjusted, comparable, EPS graph is presented below.

Figure 3 Source: Financial statements and yahoo finance

The EPS situation is also improving. For the current year, the company is expected to post more than double the EPS of fiscal 2013. In our view, this places the company among the candidates of high growth stocks of 2014. This EPS growth is supported by improved gross margins and check on the administrative expenses in the current quarter.

Cash and balance sheet:

The company has a cash balance of around $3.8 billion and a current ratio of around 2.08. The industry average current ratio is 3.08. The company is currently lagging behind industry but does not seem to have any liquidity related issues. The company generated around $1.5 billion from operating activities during the previously concluded quarter which translates to an annualized cash of $6 billion. However, we estimate the operating cash flows to be around $4.5 billion in the year 2014. The company has around 31% debt in the current capital structure, but the management is keen to reduce it by 20-25% in the coming years. Reduction of debt will lead to low financial risk but is expected to increase the cost of capital. The debt to equity ratio is around 46% which is higher than the industry average of 24%. Hence the reduction seems to be the correct course of action for Micron. Overall, the balance sheet position of the company is satisfactory considering the huge acquisitions undertaken over the last couple of years.

Segments future outlook:

The company expects that its NAND production will grow by high teen figures in the upcoming quarter while DRAM is expected to remain flat. The average selling price of NAND is also expected to decline in the upcoming quarter while the DRAM prices will remain flat. So, according to those expectations it can be inferred that the NAND is expected to show more growth in the coming quarter amid demand increase and ASP decline. The management commented in a recent conference that demand is going to be just in that 40% to 45% range probably encouraged a little bit by ASP in some of these segments. This means that the gross margin for the next quarter will be relatively lower that than this quarter. From a full year perspective, the NAND is expected to grow as DRAMeXchange forecasts that the NAND flash memory market will grow by 13% in the current year. The demand is expected to out-pace the supply of NAND and hence the prices will not be affected too much. However, a slight decline is expected in the prices of NAND in the year and hence the growth is NAND will affect the overall margins of Micron.

On the DRAM front, 12% industry growth is also expected in the current year mainly fueled by the mobile DRAM demand. This will benefit Micron amid declining DRAM cost per bit and price rise expectations of DRAM. Micron mentioned in a recent conference that mobile lead the consumption with 35% of the DRAM bit share. Servers also consumed around 20%, and servers are growing at a rate of 40% annually thanks to the cloud computing. So, basically more the 50% of the demand in DRAM business is from the high growth markets.

The next quarter outlook and the full year outlook indicate growth with improving DRAM margins and slightly low margin NAND. The long term outlook is also positive given the growth prospects of mobile and servers.

Micron technologies and additive manufacturing:

High growth is anticipated in 3D industry especially in healthcare and aerospace market. The toys market is also expected to contribute towards the growth of 3D industry. Micron does holds patents related to additive manufacturing that uses SLA (stereo-lithography), see the graph below, however, the patents it holds are related to the semiconductor manufacturing.

Click to enlarge

Figure 4 Source: lens.org

To capitalize on the growth prospects of the 3D industry, a company like 3D Systems (NYSE:DDD) should be an investment target because it is tapping into the markets in which high growth is anticipated. Micron may be able to improve its semiconductor manufacturing process using AM techniques, but we believe that Micron does not have any plans to compete in the main stream 3D printing market that includes healthcare especially dental, aerospace, automotive, toys and consumer industry. See our 3D printing coverage for suitable companies and their price entry point. We do not think that Micron's growth will be correlated to the positive developments of the 3D industry, and so investor seeking growth from 3D industry should invest mainstream 3D printing stocks. However, Micron is a very promising stock if seen in the context of the semiconductor industry.

Valuation and Final thoughts:

We valued the stock using a cash flow model in the previous update related to the company, and that should be used for the price target reference purpose. The valuation in this report is based on the metrics market relies heavily on i.e. the EPS and P/E. Valuations are as follows:

The P/E (NYSE:TTM) ratio of the company is around 14x while the forward P/E is just around 8x. So, the stock is quite undervalued based on the P/E metric. The industry average P/E is around 12x. So we used the industry average to calculate the price target.

Valuations $/share
EPS PE Price Target
High 3.88 12 46.56
Mean 2.96 12 35.52
Low 1.4 12 16.8
Click to enlarge

The price target, $35.5, using the market based valuation technique indicates that the stock is undervalued. Our cash flow based model also arrived at a PT of 35.6. However, consider Micron's current momentum the shares can touch $40 by the end of 2014.

The analysis of operational and financial performance of the company along with the industry prospects reveal that Micron is positioned to grow in the coming years. The revenues, EPS and cash flows are expected to move in a positive direction because of the growth in mobile and servers, improving demand and prices of DRAM and reduction in cost /bit by Micron due to its increased capacity; thanks to Elpida acquisition. All in all, the valuations will move upwards in the years to come with most of the appreciation coming in the current year. The derived price target also supports the growth thesis. We believe that Micron will be one of the high growing stocks of the memory chip industry in 2014 and maintain our buy rating.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: Equity Flux is a team of analysts. This article was written by our Technology analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.