Micron Technology - Investors Take Some Cash Off The Table Following A Strong Quarter And Outlook

Jun.24.14 | About: Micron Technology (MU)

Summary

Micron Technology reports solid third quarter results, offers a strong outlook.

Investors are taking some cash off the table following very strong momentum.

I am a buyer on significant dips, keeping a close eye on the supply constraints of the industry.

Micron Technology (NASDAQ:MU) reported a solid set of third quarter results which were accompanied by a solid fourth quarter outlook on Monday after the market close. Despite the strong results, investors took some profits off the table as shares have run up 32% over the past three months alone.

I am a buyer on significant dips given that the industry supply constraining conditions remain.

Third Quarter Headlines

Micron Technology reported third quarter revenues of $3.98 billion, up 72% compared to last year. Revenues were down 3% compared to the second quarter, but came in ahead of consensus estimates at $3.89 billion.

GAAP earnings came in at $806 million compared to just $43 million in the third quarter of last year, and up from the $731 million reported in the second quarter.

On a GAAP basis, earnings came in at $0.68 per share while earnings totaled $0.79 per share on a non-GAAP basis. Analysts were anticipating non-GAAP earnings of $0.70 per share.

Looking Into The Numbers

Revenues for both DRAM and NAND Flash were down slightly compared to the second quarter. The huge increase in revenues compared to last year is of course driven by pricing, growth and the acquisition of Elpida.

Gross margins came in at 34.35% for the quarter, consistent with the second quarter as lower average selling prices were offset by lower manufacturing costs. As a matter of fact, gross margins were up by 20 basis points compared to the second quarter. In comparison, margins were just 24.0% in the third quarter of last year.

Operating earnings fell from $869 to $839 million on a sequential basis as operating costs were relatively stable amidst the slight fall in revenues. The fact that net earnings rose is thanks to the fact that non-operating expenses fell from $122 million to $21 million, mainly on the back of lower debt restructuring costs.

Generally low income tax provisions thanks to past operating losses of Elpida have been helpful to earnings as well.

Looking Into The Final Quarter

For the current fourth quarter, Micron anticipates DRAM production to be up in the low single digits, compared to flat growth in the third quarter. Prices are seen flat after falling by 2% in the third quarter, offset by costs which are seen down in the low single digits.

The anticipated growth is driven by demand for PCs, a trend earlier confirmed by the likes of Hewlett-Packard (NYSE:HPQ) and Intel (NASDAQ:INTC).

NAND production is seen up in the low to mid-teens after seeing a 6% sequential decline in the third quarter. This is offset by an expected price decline in the low to mid single digits, compared to flat price developments in the third quarter. In this light, the flat manufacturing cost guidance might be a bit disappointing.

All of this translates into a fourth quarter revenue forecast of $4.0 to $4.2 billion, in line with consensus estimates at $4.06 billion.

Valuing Micron

Micron ended the quarter with $4.81 billion in cash and equivalents. Total debt has been reduced towards $5.64 billion which results in a net debt position of little over $800 million. The historically very strong earnings allowed Micron to improve the financial health of the balance sheet considerably.

So far this year, Micron has posted revenues of $12.1 billion, nearly double the amount in the non-comparable period the year before. Earnings so far came in at $1.9 billion. Based on current information, annual revenues of about $16.2 billion and earnings of $2.7 billion could be very much attainable.

At $31 per share, Micron's equity is valued at roughly $36.9 billion currently. This would value equity at 2.3 times annual revenues and 13-14 times annual earnings.

The company does not pay a dividend at the moment.

2014's Earnings Are Strong, But Impacted By Many Items

So far Micron posted earnings of $1.9 billion this year, which could increase towards $2.7 billion for the entire year. This is aided by strong momentum and acquisition of Elpida among others, as well as low tax rates.

Yet the story is not that simple, as many charges have hit the bottom line as well so far this year. For starters, there is the $233 million charge related to the liabilities of pending litigation with Rambus in antitrust and patent manners.

Other charges are $171 million in debt restructuring charges as the company is redeeming and repurchasing long term dated convertible debt outstanding. The company has to pay steep priced to redeem the debt, due to the huge run up in the share price.

Adjusting for these items, earnings could easily top $3 billion at the current run rate. Yet note that Micron paid just $215 million in income taxes on $2.26 billion in operating earnings, for an effective tax rate coming in below 10%. If these rates would increase to more normal tax rates when operating losses run out, reported GAAP earnings could be under significant pressure.

More Stable Operations Anticipated

Analysts and Micron itself are assuming that the industry consolidation has resulted in an end to the extreme price volatility witnessed over the past decade. The company is still expecting cyclicality to be apparent in the industry, yet it hopes to remain profitable even during the downturns.

Numerous bankruptcies, consolidation, strong demand and risks to increase supply have all contributed to this more favorable environment.

Micron marked the consolidation of the industry by acquiring Elpida in a deal which closed last summer. The company is now releasing quarterly forecasts, something which it did not do before. This is a clear sign that it too believes predictability has improved.

The much more favorable operating conditions have pushed shares up 44% year-to-date already, as shares are up 124% on a twelve months basis.

Note that shares were trading at just $5 towards the end of 2012. However, revenues for that year were only half of current projections for this year, while the company posted a loss of more than a billion back in 2012.

Final Takeaway

Some of the most prominent investors including the likes of David Einhorn have anticipated this consolidation perfectly, reaping huge rewards in the process. Even in 2014, shares have been on the increase while the thesis about consolidation was already well known last year. At the time, many were still skeptical about the calls and projections for continued changed industry dynamics.

As such the party continues as long as the market remains supply constraint. With Hynix and Samsung being the only two larger players remaining in the industry, the market appears to remain intact for now. Besides keeping the very strong earnings intact, there are risks for companies to build these plants. For starters there are the multi-billion dollar price tags, while new technologies are threatening to make current technologies obsolete.

I remain cautiously optimistic, although it all depends on the supply constraints remaining intact in the business. Micron has quickly shored up its balance sheet, addressed dilution and now trades at 13-14 times earnings. While these appear to be attractive multiples, it all depends on the sustainability of these earnings, as I am worried that big money will attract big investments at some point in time.

I remain on the sidelines, being a buyer on significant dips like the one occurring in April, given that current conditions remain.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.