Micron: A High Risk Play With Significant Upside

| About: Micron Technology (MU)

Micron (NASDAQ:MU) has had a pretty rough year. The company's earnings per share have been declining for the past 8 quarters and the company has been posting widening net losses for the last four quarters. It's not tough to see why.

DRAM (in particular, DDR3) prices are incredibly low and competition from heavyweights like Samsung is stiff, making it very difficult for Micron to keep margins up. In fact, Elpida, one of Micron's major competitors, recently filed for bankruptcy because they simply couldn't stay afloat.

Micron doesn't just make DRAM, though. They are one of the leading producers of NAND flash, the key technology behind solid state drives. However, a potential problem, again, is that NAND flash prices are quickly dropping due to very high levels of competition.

However, even in the face of this doom and gloom, I think that there is a fair chance that Micron, in FY2013, can start turning quarterly profits again and see significant share price appreciation going forward. Here's why:

1. Solid State Drives

Solid state drives are very likely going to entirely replace standard hard disk drives such as those from Western Digital (NYSE:WDC) and Seagate (NASDAQ:STX). These drives depend on NAND flash memory, which is a type of non-volatile (meaning that it holds the data once the power turns off, unlike DRAM, which is volatile) memory that consumes significantly less power than traditional disk drives while at the same time providing an order of magnitude more performance.

Micron owns their own NAND fabs (and has a joint fab with Intel (NASDAQ:INTC) for their high end flash), so on their own in-house solid state solutions, they have all of the pricing advantages with their own products that come with being vertically integrated. Furthermore, they supply NAND to the fabless SSD manufacturers, so there's significant revenue to be had there.

However, the problem here is that NAND prices are falling like a brick, so even though the company is selling more NAND (due to SSDs becoming much more popular), they are having a difficult time posting an operating profit. I expect that the NAND prices will continue to gradually fall until bottoming out for a while. It's up to management to figure out how to swing to profitability in the face of these market conditions. More widespread adoption of flash memory across the compute continuum will certainly help sales, but if management can't keep margins in check as sales grow, then the losses will only become wider.

2. DRAM Could Make A Comeback

DRAM, another major part of Micron's business, is also suffering from extremely aggressive pricing pressure. The margins are razor thin here -- and no wonder! A quick scan of Newegg tells me that I can buy an 8GB kit of Crucial (this is Micron's consumer brand) DDR3-1333 for $42. Now, for mainstream users, 4GB will be enough for a while, especially as it becomes more and more clear that users are just fine using tablet computers that have only 1GB of memory.

However, there's a silver lining here: that tablet computer or smartphone can get away with 1GB of memory because there's a large cloud infrastructure that does a good portion of the heavy lifting. These servers require a lot of memory, and server grade memory with higher density, ECC-enabled memory chips command a significant premium to the typical consumer memory modules.

Further, as is usually seen with the release of new DDR standards, I believe that the introduction of DDR4 in the 2014-2015 time frame will bring average selling prices of DRAM back up. Further, as chips such as Intel's "Haswell" and AMD's "Kaveri" come out with significantly more powerful integrated graphics, they will require significantly more memory bandwidth (a big advantage discrete graphics chips still have is access to very high bandwidth memory -- something that will be the achilles heel of integrated graphics as a really viable solution for high end gaming on PC).

Finally, if MU acquires Elpida, then that gives Micron a significant piece of the DRAM pie, which leads to higher selling prices on DRAM due to less competition. I would have some concerns if they were to go through with the acquisition for roughly $2B, but I think that gaining a significant piece of the DRAM pie (and keeping it out of the hands of the already gargantuan Samsung or the formidable Hynix) would bring ASPs up and be a generally positive thing long term for the company.

3. Valuation

The company is trading at 0.66x sales, and 0.71x book value, which seems to indicate that the shares are cheap here. However, with the aforementioned earnings losing streak due to cutthroat, decreasing margins, I would really like to see a clearer path to profitability in the near-to-medium term. Analysts model a FY2013 EPS 0f $0.19. Such an EPS would give a P/E of about 29 at current levels, but this would be an excellent beginning of a reversal from the very negative EPS.


So Micron is indeed a high risk play, but I believe that we're close to the bottom. I doubt we'll see last year's low of $3.97 (unless the macro situation continues to deteriorate, in which case all bets are off), so I would say low to mid $5's represents a solid entry point into this stock if you're willing to hold for a while and let everything play out. It's a fairly high risk position, but if Micron gets back into profitability, then there's some very real reward to be had.

Disclosure: I am long INTC.