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Summary

  • Elpida acquisition has been boon for margins and cash-flow.
  • Still worried about fiscal 2015 and 2016 estimates.
  • Micron less undervalued today at $31-$32.
  • Sentiment is wildly bullish.

Micron Technology (NASDAQ:MU), the commodity NAND and DRAM semiconductor memory producer, reports its fiscal Q3 '14 financial results after the bell on Monday, June 23, 2014.

Analyst consensus is expecting $0.69 in earnings per share (NYSEARCA:EPS) on $3.886 bl in revenues, versus EPS of $0.04 and $2.3 bl in the year-ago quarter.

Since the March '14 report, the Q3 '14 current consensus revenue estimate has been revised higher $41 million from $3.845 bl to $3.886 bl, while the EPS estimate has been revised higher from $0.68 to $0.69 per share.

Fiscal Q1 '14 results were pretty solid: revenue grew 98% y/y, even though MU guided DRAM and NAND pricing down 15% and 7% sequentially.

The Elpida acquisition is still influencing the 2014 estimates since there is no revision of 2013 numbers to "true-up" or pro-forma alteration to the numbers, hence we still don't know "organic growth" for MU in '14 versus last year.

Note the substantial impact Elpida has had on MU's margins, starting with the August '13 quarter:

Margins8/14 q45/14 232/14 q211/13 q18/13 q45/13 q32/13 q211/12 q108/12 q405/12 q303/12 q212/11 q109/11 q4
Gross marginn/an/a34.16%34.44%42.00%23.99%17.61%11.83%11.16%10.77%12.97%14.59%15.00%
y/y changen/an/a16.55%22.61%30.84%13.21%4.65%-2.76%-3.84%10.77%12.97%14.59%15.00%

Operating margin

n/an/a21.5%13.6%9.3%8.8%-1.6%-8.6%-7.1%-8.8%-7.2%-3.9%-2.4%
y/y changen/an/a23.1%22.2%16.4%17.6%5.6%-4.6%-4.7%-8.8%-7.2%-3.9%-2.4%

Net margin

n/an/a17.8%21.8%11.7%7.4%-0.1%-15.0%-12.4%-14.7%-10.8%-8.9%-6.3%
y/y changen/an/a17.9%36.8%24.1%22.1%10.7%-6.0%-6.1%-14.7%-10.8%-8.9%-6.3%

* Source: internal spreadsheet

The reader can quickly see the influence Elpida has had on MU's margins as operating margins (pre-acquisition) were mid-single-digits, but now have moved into the low 20% range.

Cash-Flow too:

Statement of Cash Flows8/14 q35/14 q22/14 q111/13 q18/13 q45/13 q32/13 q211/12 q108/12 q405/12 q303/12 q212/11 q109/11 q406/11 q303/11 q2
Cash provided by opsn/an/a$1,390$1,507$481$624$470$236$529$529$529$529$621$621$621
Cash provided by investingn/an/a($472)$21$97($171)($999)($639)($578)($578)($578)($578)($550)($550)($550)
Cash provided by financingn/an/a($271)($735)$219($74)$131$46$124$124$124$124($259)($259)($259)
Net change in cashn/an/a$647$793$797$379($398)($357)$75$75$75$75($188)($188)($188)
Cash generated from oper.n/an/a$1,390$1,507$481$624$470$236$529$529$529$529$621$621$621
Capex (incl pymts on eq purch cont)n/an/a($708)($526)($118)($235)($353)($538)($372)($324)($429)($746)($928)($534)($840)
cash generated from stk optnsn/an/a$0$0$0$0$0$0$0$0$0$0$0$0$0
Dividendsn/an/a$0$0$0$0$0$0$0$0$0$0$0$0$0
Free-cash-flown/an/a$682$981$363$389$117($302)$157$205$100($218)($307)$87($219)
4q trailing CFOn/an/a$4,002$3,082$1,811$1,859$1,763$1,822$2,114$2,207$2,299$2,392$2,484$2,637$2,790
4q trailing CFO yoy gro raten/an/a127%69%-14%-16%-23%-24%-15%-16%-18%-19%-20%1%30%
4q trail capexn/an/a$1,587$1,232$1,244$1,498$1,587$1,663$1,871$2,427$2,637$3,048$2,872$2,098$1,718
y/y growthn/an/a0%-26%-34%-38%-40%-45%-35%16%53%195%366%259%211%
capex as % of revenues
capex as % of cash-flown/an/a40%40%69%81%90%91%89%110%115%127%116%80%62%
4q trailing FCFn/an/a$2,415$1,850$567$361$176$159$243($221)($338)($657)($388)$539$1,072
4q trailing FCF gro raten/an/a1272%1067%133%
FCF yieldn/an/a9%8%3%3%2%
Common stk issuance (dilution)$112$112$12$12

* Source: internal spreadsheet

Note the improvement in cash-flow and free-cash-flow after the Elpida acquisition closed. Micron's November '13 quarter was the first full quarter of Elpida's results.

Valuation - here is what we worry about:

Micron's EPS and revenue estimates for fiscal '15 and '16 (updated with current estimates below)

Micron
n/afy 2014fy 2015estfy 2016estfy 2014 revfy 2015 revestfy 2016
n/aestesty/y groesty/y groestesty/y groest
June '14 (current)$3.10$3.255%$3.14-3%$16,070$17,70410%$17,7040%
May '14$3.02$3.051%$3.01-1%$15,990$16,8295%$17,4324%
April '14$3.02$3.041%$2.84-7%$15,917$16,6745%$17,1503%
Mar '14$2.96$2.970%$3.166%$16,027$16,6164%$17,5165%
Dec '13$2.09$2.289%$2.5411%$15,162$15,8785%$15,8160%
Sept '13$2.10$2.3210%$1.85-20%$14,367$15,7289%$16,4535%
June '13$0.95$1.2734%n/an/a$10,511$11,1816%n/a
Mar '13$0.69$1.0755%n/an/a$10,031$10,5525%n/a
# of est's26278303010
* Source: ThomsonReuters current and historical consensus estimates
* fy = fiscal year
* Fiscal year ends August every year

* Source: estimates courtesy of ThomsonReuters, internal spreadsheet

The first 2 columns are the expected consensus fiscal 2014, 2015 consensus EPS estimate, and the 4th column is the expected 2016 EPS estimates.

The 3rd and 5th columns show the expected y/y EPS growth rate for 2015 and then 2016, and how those expected growth rates have changed.

What I'm looking for is forward growth rates for MU's EPS in 2015 and 2016 AFTER the Elpida acquisition influence, which occurs mostly in fiscal 2014.

Repeat the same process for the revenue consensus estimates.

The point being that analysts are looking for low- to mid-single-digit EPS growth for 2015 and 2016 (actually, negative EPS growth for 2016), while the consensus revenue estimates are moving higher for fiscal 2015.

Bottom line, after Tuesday night's report and through Wednesday, let's see how analysts revise their fiscal 2015 EPS and revenue estimates, which is just 18 months out from here.

Finally, when talking about valuation: MU still looks cheap. Trading at $31-$32 per share, MU is trading at 10(x) the consensus expected 2014 EPS of $3.10, 10(x) 2015 EPS consensus of $3.25 and 10(x) the consensus EPS estimate for 2016 of $3.14, for expected y/y growth in 2014, 2015 and 2016 of 1045%, +5% and -3%, respectively.

Expected revenue growth the next three years is 77%, 7% and 3%, respectively using the above revenue data.

The question to be asked though, is: "Is low $3.00 EPS estimates for 2015 and 2016 the right ballpark ?" One analyst thinks MU could generate $5 per share.

For now, though, you can see how the 2014 compares are distorting everything.

Cash-flow valuation is very reasonable with MU trading at 7(x) 4-quarter trailing cash-flow and a 9% free-cash-flow yield.

Our internal intrinsic value model estimates MU is worth in the high $30s per share, so the undervaluation gap we saw in the stock since early 2014 has narrowed considerably, from being 50% undervalued as of the February '14 report, to being just 25% undervalued coming into the May '14 report.

And our internal model is based on an estimated P/E ratio, using a forward EPS estimate. If the forward estimate moves up materially, so will I expect our estimated intrinsic value estimate to move higher.

The thing is, Morningstar still carries a $12 intrinsic value estimate on MU, and that isn't to be ignored. Each boom cycle we hear that "this time is different" and I consider that Morningstar valuation estimate to be a warning that not everyone is convinced MU has the discipline to not destroy capital during a prolonged market downturn.

Has the competitive landscape changed that much for the commodity DRAM and NAND producers ?

Technically, the semi stocks look great. These are capital intensive businesses to be sure, so a PC recovery and strong NAND prices if sustainable would be a boon for all the semiconductor companies.

Here is one article just published today on Forbes from Trefis that talks about the improving PC environment.

Here is a quick listing of positives and negatives we see in MU right now:

Positives:

1.) Margins have expanded nicely with Elpida acquisition.

2.) Cash-flow valuation is reasonable and the free-cash-flow generation is robust, which is a huge positive for MU.

3.) The PC recovery and the move into mobile DRAM hopefully sets the company on a sustainable growth path for the future.

4.) Could MU ever generate sustainable cash-flow and free-cash-flow enough to repurchase stock and pay a dividend?

5.) There is no question the sector and all the stocks have come to life, and are trading well.

Weaknesses:

1.) Forward estimates for 2015 and 2016 are showing growth, just not robust growth. Low to high single digit EPS growth isn't all that exciting and the 10(x) P/E for 10% growth isn't too exciting either. I'd like to see both the EPS and revenue consensus for 2015 move sharply higher as we move through the summer of 2014 to sustain this kind of stock momentum.

2.) MU is starting to see some dilution from common stock issuance. Companies and employees "sell high," so to speak. Not onerous yet, though.

3.) Up 46% year-to-date, the stock is overbought on all chart timeframes, i.e., daily, weekly, monthly.

4.) Sentiment is wildly bullish, which scares me the most.

We will be watching what happens to the 2015 EPS and revenue consensus after Tuesday's report.

The recovery in the PC market is a nice plus for MU as the commodity DRAM segment is 46% of revenues and 60% of operating income as of the February quarter.

Readers should NOT expect MU management to say "the cycle is over" when the top is hit. The mid-to-late 1990s was a painful lesson, so better to be an early seller when you have a company where capex is 40% of cash-flow.

In terms of total MU's position within client accounts versus our total assets, we have a 1.6% position in MU and have a 98% gain across the composite.

We haven't sold any MU since establishing the original positions, but I guarantee you, the trigger finger is itchy.

Here is a monthly chart for MU, with a retro look, back to the late 1980s. The breakout over $20 looks pretty solid.

(click to enlarge)

Source: Micron Technology Earnings Preview: Margin Expansion Robust, Stock Less Undervalued