We’re focusing on the pros and cons of investing in Micron.
Specifically, we’re focusing on its asset turnover, financial leverage and growth potential.
We also compare it to a sub-industry peer and find that Micron looks undervalued right now.
In this article we're focusing on the strengths and weaknesses of Micron (NASDAQ:MU) and comparing the company to Avago Technologies (NASDAQ:AVGO). We feel that a comparison of the two stocks could prove to be useful and worthwhile since, although the two companies are of a very different size (Micron's market cap is $35 billion, while Avago's is $19 billion), the two companies occupy the same GICS sector of information technology. They also sit in the same GICS sub-industry of semiconductors and we're well aware that many investors apportion their capital based on sector and sub-industry, so we think a comparison of the two could prove to be a helpful guide. As ever, we'd love to hear your views in the comments section below.
One of the facets of a company that we focus on is its asset turnover. We do this because we feel it highlights how efficiently a company is utilizing its asset base, and whether it is generating enough sales from the assets it holds. Moreover, changes over time as well as a comparison to a sector peer can highlight discrepancies in this space.
We're encouraged by Micron's asset turnover ratio of 0.54. This shows that the company generates $0.54 of revenue for every $1 of assets, which highlights that Micron is effectively utilizing its asset base. Indeed, Micron's use of its asset base has been very consistent over the last 10 years, with the company's asset turnover ratio fluctuating only modestly during the period. It has ranged from a low of 0.39 in 2009, when the sector experienced a highly challenging environment, to a high of 0.65 in 2010 as sales growth picked up strongly. In fact, Micron's asset turnover ratio is only slightly below where it was 10 years ago (0.54 versus 0.59) which shows that, even though the company's asset base has grown by a considerable amount (two-thirds in the last five years alone), it has been able to maintain its impressive level of efficiency.
In comparison, Avago is able to squeeze more revenue out of its asset base than Micron. Indeed, its asset turnover ratio is extremely impressive at 0.8 and, although it has dropped back in recent years from a high of 1.02 in 2011, it is still higher than Micron's equivalent number. This shows that, while Micron is able to grow its total assets over time and squeeze similar sales levels out of it, Avago appears to be able to do a slightly better job at this than its sub-industry peer.
One feature of Micron's business model that concerns us slightly is its use of financial leverage (total assets dividend by total equity). Certainly, we appreciate that increased financial leverage can help to bolster returns for equity holders, but we note that the company has increased its level of financial leverage significantly in recent years.
For example, in 2004, Micron's financial leverage ratio was 1.38, which in itself is moderately high. Today, though, it stands at 2.09, which is a significant increase. Clearly, interest rates are more favorable now than in 2004, so on the one hand it makes sense to borrow more, but we're at the low ebb of the interest rate cycle these days, so we feel it may not be prudent for Micron to continue to rely on increasing debt levels to facilitate higher returns to equity holders moving forward.
Meanwhile, it's a different story at Avago. Its financial leverage is much lower at 1.18 and, unlike Micron, it has been able to lower its dependency on debt in recent years. For example, financial leverage was as high as 2.82 in 2007, before falling gradually in the intervening years. This shows, we feel, that the company could be better positioned to deliver more reliable returns for investors that are not subject to the same degree of risk as those of Micron.
When it comes to growth potential, both companies have very strong prospects. For example, Micron is expected to post earnings that are 29.4% higher for the year to August 2014 than they were for the prior year, while its numbers for next year are set to be even better. Indeed, its bottom line is expected to be 8.1% higher in the next financial year, thereby highlighting that the company remains an attractive growth play.
However, while we like Micron's growth prospects, we like Avago's even more. That's because it is expected to grow profits by an astounding 66% in the current year to the end of October, while next year's figure of 32.4% also is highly impressive. As a result, while Micron is a strong growth play, it is beaten into second place by its sub-industry peer.
Although we raised concerns regarding Micron's financial leverage, as well as the fact that its asset turnover and growth potential are not as strong as those of Avago, Micron's current valuation appears to be unjustly low. For example, it trades on a forward P/E of just 9.6. That's considerably lower than Avago's P/E of 14.6 (which itself is not particularly high), while Micron's five-year PEG ratio of 0.5 is more attractive than Avago's equivalent figure of 0.7.
However, where the difference in value between the two companies really shows is with regard to the EV/EBITDA ratio. Even though Micron utilities much more financial leverage than Avago, its EV/EBITDA ratio is far lower at just 7.6, versus 20.5 for its rival. As a result, we believe that Micron is mispriced at current levels and could outperform Avago moving forward.
We're impressed with both companies' asset turnover numbers, particularly because they have been generally maintained over a relatively long period. This highlights their efficiency when it comes to generating sales from assets. While we raised concerns surrounding Micron's capital structure, we feel that its present valuation is simply too low versus its sector peer. Sure, Avago has lower financial leverage and better growth prospects, but Micron's valuation appears to price these in at a too great an extent. As a result, we feel that Micron could outperform its sub-industry peer moving forward as the market corrects what appears to be a mispricing going forward.