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Summary

  • Micron should continue to earn a leader's share of the profits in DRAM and NAND.
  • The estimated intrinsic value is $31 per share.
  • The technicals are bullish but could be turning bearish.

Micron Technology, Inc. (NASDAQ:MU), the semiconductor solutions provider, reported solid fiscal second quarter results. The acquisition of Elpida significantly improved the profitability of Micron. But the acquisition of Elpida also exposed the combined company to litigation from shareholders of Elpida that could have a material adverse impact on the future results of operations. The profitability improved during the fiscal second quarter relative to the first, but pricing in the DRAM market is volatile and could adversely impact results during the second half of the fiscal and/or calendar year.

High level, the smartphone market is expected to continue to provide strong demand for Micron's DRAM solutions. Also, though PC sales are slumping, newer PC models are increasing DRAM capacity. DDR4 and NAND Flash should ship into the enterprise market. Overall, the company and industry dynamics are favorable.

As is, the current share price of Micron is almost 16% undervalued by the market. At $24 per share or lower, overweighting Micron would be almost a no-brainer.

Recent Developments

  1. Micron released a new SATA SSD for data centers; the drive comes in 120-800 GB capacities.
  2. Micron is ramping production of its DDR4 memory.

Analyst's Note

Micron Technology, Inc. is one of the world's leading providers of advanced semiconductor solutions. The company manufactures and markets DRAM, NAND Flash and NOR Flash memory, as well as other innovative memory technologies, packaging solutions, and semiconductor systems for use in leading-edge computing, consumer, networking, automotive, industrial, embedded and mobile products.

For the year ending (in millions of dollars except per share data):

2013-08

2014-08E

Net sales

9073

17500

Gross profit

1847

5688

Operating income

236

3325

Adjusted net income

(294)

2965

Diluted EPS

(0.28)

2.46

Thus far this year, revenues have come in well below my forecast of $19.5B. While I expect second half to be stronger than the first half, I'm decreasing my full-year revenues forecast to $17.5B. The gross margin has come in slightly above my forecast of 31%; but with that stated, I think that the gross margin continues to improve during the back half of the year. Consequently, I'm increasing my gross margin forecast to 32.5%. The operating margin is tracking in line with my forecast so far this year, but I'm increasing the forecast to 19% from 17%. Also, the net profit margin is increased from 12% to 15% with the adjusted net profit margin at 17%. The above table shows the revised data.

For the full year, mobile demand emanating from China, and globally, is expected to drive DRAM and NAND sales. Also, sales into the server market are expected to be firm with the overall server market being soft; DDR4 will ship into the enterprise end market. The PC market is fragmented with DRAM sales slumping but demand increasing for NAND flash in SSDs. The PC SSD attach rate increased from 10% to 15-25%. Also, low-to-mid range smartphones are adding DRAM capacity to levels close to high-end versions.

The liquidity appears ample and the solvency position seems solid. The solvency position is forecasted to improve mostly through an increase in equity capital via retained earnings. The increase in capital expenditure appears overdue as the relative position of capital stock was deteriorating. Also, the $312 million investment in Inotera, a wafer supplier, is accounted for using the equity method. There are a couple of material issues that arise from the Inotera asset. One, at the end of 2013, Inotera was not in compliance with its loan covenants and must cure the breach of the loan covenants by June 30, 2014. Two, the Qimonda estate is seeking through litigation the return of the Inotera shares, and the court ordered Micron to return the shares to the Qimonda estate plus supply additional compensation. Micron intends to appeal the court's ruling. The market value of the Inotera stake was $1.81 billion at the reporting date.

Additionally, there is pending litigation related to the Elpida acquisition that would have a material adverse impact on the consolidated results of operations.

For the year ending (in millions of dollars):

2013-08

2014-08E

Cash provided by operations

1811

5775

Capex

1244

2900

FCFF

795

3225

FCFE

945

1950

The forecast for 2014 cash provided by operations decreased from $6.44 billion to $5.78 billion. This adjustment adversely impacted the free cash flow forecasts. Before I get to that, the current pace of capital expenditure is well below management's guidance, and I, as well as other analysts, believe capital expenditure could come in well below $2.9 billion, which would be accretive to free cash flow. The table above provides the revised estimates.

While the reported results trailed my estimates, and there are significant material risks outstanding, given MU's industry exposures, I'm bullish on the underlying operations of the firm. MU should be able to generate a sizeable return on invested capital for the foreseeable future.

General Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in Micron in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for Micron's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in Micron.

Portfolio & Valuation

(click to enlarge)

MU is in a bull market of intermediate and primary degree. But it appears that the impulse wave of primary degree is nearing an end and that a corrective wave of primary degree is beginning. A decline back to the $21 per share level would add conviction to the theory. The previous interpretation is that shareholders would be in for a bear market of at least intermediate degree.

Monthly expected returns

Quarterly expected returns

Quarterly standard deviation of returns

Sharpe ratio

3%

9.09%

24.65%

0.34

Estimated intrinsic value

Forward price multiples

Optimistic

$48.47

P/E: 10.94

Base case

$31.16

P/S: 1.85

Pessimistic

$22.50

P/BV: 3.07

Current price

$26.93

P/CF: 5.62

Based on the estimated fundamentals of the firm, MU is undervalued by 15.7%. The estimates incorporate the change in the industry landscape and the improvement of the solvency position. At 11 times forward earnings, MU is cheaper than the S&P 500.

Source: Micron: Solid Second Quarter And Undervalued Shares