I like to keep a close eye on the developments of the technology industry, and sometimes, I come across interesting investment options, like Micron Technology Inc. (NASDAQ:MU). Although I take many aspects into account when I analyze a company, in this article, I will focus on debt and liabilities. I will look into Micron's total debt, total liabilities and debt ratios.
This analysis is crucial to understanding the risks of investing in this company, and will allow us to appreciate how leveraged a company is, and what kind of returns to expect for a long-term investment. It will also allow us to elucidate if the company is likely to maintain its capital and use it for future growth. As a memory chip manufacturer for computers and other electronic devices, Micron has been consistently exposed to the immense competition (SanDisk Corporation (SNDK), Toshiba (OTCPK:TOSBF), Hynix (OTC:HXSCF), etc.) and cyclical disparities between supply and demand in the industry.
While the DRAM segment currently accounts for 30%-40% of annual sales, management's effort to double down on this area by acquiring DRAM manufacturer Elpida for $2.5 billion in 2012 caused debt levels to increment substantially. The purchase will undoubtedly expand Micron's scale and DRAM manufacturing capacity, but I'm not sure this strategic move will be enough to compete against industry rival Samsung, which currently dominates the memory technology market.
Total Debt to Total Assets Ratio
This metric is used to measure a company's financial risk by determining how much of the company's assets have been financed by debt. It results from adding short-term and long-term debt, and then dividing this figure by the company's total assets. If the outcome is higher than 1, it means that a company's total debt surpasses the value of its total assets. Au contraire, a debt ratio smaller than 1 indicates that a company's assets are worth more than its total debt. The total debt to total assets ratio (especially when complemented with other measures of financial health) can come in extremely handy when investors want to determine a company's level of risk.
Micron's total debt to total assets ratio has increased over the past three years from 0.13 to 0.31. This indicates that since 2010, the company has added more total debt value than total asset, which is not a good sign for bond investors. However, since the ratio of 0.31x is smaller than 1x, the financial risk faced by the company is relatively low: its assets' value comfortably surpasses its total debt levels.
Debt ratio = Total Liabilities / Total Assets
The debt ratio shows the proportion of a company's assets that is financed through debt. If the ratio is less than 0.5, most of the company's assets are financed through equity, but to the contrary, assets are likely being financed through debt. Companies with high debt/asset ratios are said to be "highly leveraged", meaning they could be in danger if creditors start to demand repayment of debt.
When looking at Micron's debt ratio over the past three years, we can see that it has increased from 0.42 to 0.51, which is discomforting. Given that 2013's TTM ratio surpasses the 0.50 mark, we can assume that most of the company's assets are financed through debt. As the figure grows, so will the risk of investing in this firm.
Debt-to-Equity Ratio = Total Liabilities / Shareholders' Equity
The debt-to-equity ratio is another leverage ratio that compares a company's total liabilities with its total shareholders' equity. This is a measurement of how much suppliers, lenders, creditors and obligators have committed to the company versus what the shareholders have committed. A high debt-to-equity ratio generally means that a company has been aggressive in financing its growth with debt, which can result in the company reporting volatile earnings. In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, and therefore, is considered a riskier investment.
Compared with 2011, Micron's debt-to-equity ratio has increased from 0.73 to 1.08 (in 2013). I prefer companies that have a very low or minimal debt-to-equity ratio. Also, the fact that the company's ratio currently surpasses 1x (1.08) indicates that shareholders have invested more than suppliers, lenders, creditors and obligators, which implies a high risk for the company and its stockholders.
Capitalization Ratio = LT Debt / LT Debt + Shareholders' Equity
(LT Debt = Long-Term Debt)
The capitalization ratio tells investors the extent to which the company is using its equity to support operations and growth. This ratio helps in the assessment of risk, because companies with a high capitalization ratio are considered to be risky: if they fail to repay their debt on time, they can become insolvent. This can also cause difficulties in receiving more loans in the future.
Between 2011 and 2013, Micron's capitalization ratio has grown from 0.17 to 0.33, meaning that the company has reduced its equity levels in relation to its long-term debt, and has thus had less equity to support its operations and grow. Moreover, the current ratio (0.33) indicates moderate financial risk.
Cash Flow to Total Debt Ratio = Operating Cash Flow / Total Debt
This coverage ratio compares a company's operating cash flow with its total debt, in addition to providing an indication of a firm's ability to cover total debt with its yearly cash flow from operations. The larger the ratio, the better a company can weather rough economic conditions.
As Micron's ratio currently stands below 1x, the company does not have the ability to cover its total debt with its yearly cash flow from operations, which is definitely not ideal.
Several investment gurus have been reducing or selling out their shares in Micron this past quarter, such as Seth Klarman and Robert Karr, making me somewhat skeptical about the company's profitability.
Furthermore, many analysts currently have a flat outlook for Micron. Analysts at Yahoo Finance, for example, expect the company's EPS to remain stagnant at $2.96 for this fiscal year and the next one. Analysts at Bloomberg, on the other hand, are estimating revenue to grow very slowly from $16.01B this fiscal year to $16.63B for the upcoming year.
As seen in the debt analysis above, Micron's balance sheet is rather messy and unstable in many aspects, which makes me skeptical about the safe sailing through this investment. While I do think the company will continue to increase sales and profits through its DRAM segment, the strong competition and cyclical nature of the industry's prices make me uncertain regarding shareholder benefits. While the current returns on assets are at a solid 6.2%, this metric has been so unstable over the past three years, ranging from a high point of 13% in 2010 to a low point of -7.2% in 2012, that investors should really not expect much in return from this firm.
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.