Micron Is A Buy - Its DRAM Clients Seek Long-Term Contracts

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 |  About: Micron Technology Inc. (MU)
by: Motek Moyen

Summary

Micron is better off granting long-term supply contract requests of its clients.

Samsung and SK Hynix will eventually return to their maximum DRAM production capacity.

Micron is a Buy because it can lock-in DRAM customers now with long-term supply agreements.

DRAM customers are reportedly seeking long-term supply contracts with Micron (NASDAQ:MU). The 200,000 wafers/month capacity of Micron makes it the perfect long-term DRAM supplier to customers who require a steady source of DRAM chips. This development, if true, is a long-term tailwind for Micron.

The DRAM customers do not want to pay for more expensive memory chips because of the expected tight supply of DRAM. DigiTimes already reported last April that Micron was planning to hike DRAM prices to take advantage of the short supply.

Samsung (OTC:SSNLF) and SK Hynix (OTC:HXSCL) are still unable to help address the insufficiency of DRAM supply. On the surface, Micron can really exploit this situation and hike DRAM prices to new highs. However, Micron may suffer a long-term backlash if it takes this path.

Clients with no other choices will bear and grin the proposed new higher prices. However, these customers will definitely feel exploited and are likely to abandon Micron as soon as it is possible to do so.

Long-Term Purchase Contracts to Lock-In Customers

The better alternative is for Micron to grant long-term supply contracts to lock-in customers. The DRAM customers who sign up for multi-year agreements benefit from a steady supply of memory chips at today's prices. On the other hand, Micron benefits more because its factories' future DRAM production output already has sure buyers. Minimizing customer defection is always good for business.

SK Hynix and Samsung will eventually solve their DRAM production problems. Once those two companies start rolling out their maximum production capacities, DRAM prices will go down. Micron has a very good reason to lock-in customers now at today's prices.

Tying up customers with binding multi-year supply contracts ensures their long-term loyalty to Micron. The industry consolidation that resulted in Micron buying out Elpida has stabilized the memory industry. However, Samsung and SK Hynix can still initiate price wars anytime they need to unload their unsold DRAM inventory.

The so-called oligopoly in memory chips is a flimsy concept.

Much Improved Semiconductor Company

Micron is one of most improved semiconductor-related companies in terms of sales for Q1 2014. IC Insights ranks Micron + Elpida as the fourth-best company in terms of sales growth. The Q1 2013 combined sales of Micron and Elpida was calculated and compared to this year's Q1 results. For the first quarter of this year, Micron posted a 27% sales increase year-over-year.

Long-term supply contracts with old and new customers will maintain Micron's revenue surge. DRAMeXchange is projecting a 30% growth for global DRAM demand this 2014. The high demand for mobile memory chips is one reason why the global DRAM industry's market value will reach $45.9 billion in 2014.

Mobile DRAM will account for 30% of total global DRAM sales this year. It will replace the PC DRAM as the most popular memory product. Micron is currently second only to Samsung in mobile DRAM sales. However, with Elpida under its wing, Micron's market share is expected to grow higher.

Elpida's largest customer is Apple (NASDAQ:AAPL). Apple continues to see growth in its desktop, laptop, and mobile iOS device sales. The upcoming iPhone 6 and new Apple TV should help stimulate more demand for Elpida DRAM. I'm also sure that Apple already has a long-term contract with Micron.

Conclusion

Micron is still a Buy. The stock has risen significantly over the last 12 months. MU has delivered a 139.97%+ gain from its 52-week low of $12.31. However, MU can still go higher from the tailwind that long-term supply contracts can deliver. Micron's future DRAM production has minimal risk of inventory write-offs.

The Elpida acquisition last year has helped Micron become the DRAM producer that customers can rely on for steady supply of memory chips. My Buy rating for MU is in line with the Buy recommendation of 12 analysts from BarChart.

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Source: BarChart.com

In spite of the 38.69% YTD run-up, the technical indicators are still calling for a Buy for Micron.

Click to enlarge

Source: BarChart.com

Disclosure: I am long AAPL. 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.