- Micron will likely breach the $10 floor in the coming couple of months.
- There are no indications of an immediate reversal in declining DRAM prices.
- The stock is trading below its Tangible Book Value, but it can fall more.
This article is going to focus on looking at the other side of the arguments raised in the aforementioned article. Provide insights as to why the bears have it wrong on Micron. Most importantly, the article aims to offer a compelling argument as to why shorting Micron is not a good idea.
- Response #1: It is true that "there are no indications of an immediate reversal in declining DRAM prices." But it is not true to imply that Micron's revenues will continue to deteriorate as DRAM prices decline.
One of the points raised in the article that I concur with is that Dynamic Random-Access Memory ("DRAM') average selling prices have been falling. This has been one of Micron's main challenges. As a result, DRAM's gross margin was ~20% lower in Q4 2016 y/y.
But the decline in DRAM's average selling prices is not new. This is why in Q2 2015, Micron decided to reduce PC DRAM sales. It was not cost effective for Micron to mass produce DRAM's on 25nm nodes and above while demand reduced and prices declined.
"Our sales guidance anticipates taking strategic action to reduce PC DRAM sales this quarter given the recent demand and price weakness." - Mark Heil, Micron Technology's earnings call transcrip, Q2 2015.
Because DRAM sales constituted more than 50% of Micron's total sales, the stock price has declined by ~60% since Q2 2015 to reflect the anticipated decline in DRAM prices and Micron's decision to reduce PC DRAM sales.
This is why I believe that the decline in DRAM prices are already reflected in Micron's stock price.
But that is not all. Micron has been ramping up DRAM production on its 20-nanometer node. Giving it a competitive cost position and a catalyst to boost DRAM output. This will help Micron mitigate losses emanating from falling DRAM average selling prices.
"Internally and from our operations perspective, Micron remains focused on a few key operating priorities. For DRAM, we continue ramping 20-nanometer. This technology node will represent more than 50% of our fab bit output in the current fiscal quarter." - Micron's Q2 2016 earnings transcript
Micron's 20-nanometer nodes, from 25nm-30nm, will allow Micron to compete (hopefully gain more marker share) with the market leader in the 20nm race, Samsung. Smaller nodes will allow Micron to keep prices low. Making it more competitive. Consequently, falling average DRAM's selling prices will be mitigated by cost reductions and volume (increased market share).
This is why Micron stated in its Q2 2016 slides that "we expect strong double digit bit growth and related cost reductions for DRAM in FQ3 as a result of the deployment of our 20nm technology."
Hence the reason why I started that it is not true to imply that Micron's revenues will continue to deteriorate as DRAM prices decline.
- Response#2: For a viable business with a strong balance sheet, trading at undemanding valuations, Tangible Book Value ("TBV") can imply limited downside. Plus, Bank of America ("BoA") is a bad comparable company to Micron.
The second point I want to tackle is why justifying a further drop in Micron's stock price using BoA's TBV as an example is incoherent.
Quoted bear argument raised: "One reason why the stock could be respecting the level of $10 is because it is closer to the tangible book value of the company. Some analysts like to view this as a strong indication that the stock has limited downside. But as we have seen in the case of Bank Of America (NYSE: BAC), the stock can drop severely below its TBV. Bank of America currently has a TBV of $16.17 per share while the stock trades at $14.56. Earlier, it was trading at a 20% discount to its TBV. I'm expecting a similar case for Micron, and recommend that investors do not make purchases in haste."
First and foremost, BoA (NYSE:BAC) is a bad example to use because BoA and Micron are not comparable companies. The reason BoA is trading below TBV include: the indecisive FED, increased regulatory pressure, litigation and related costs, threats of cybersecurity, falling energy prices etc. Headwinds that do not have material impact on Micron.
As of Q2 2016, Micron beat on the bottom line but missed on the top line. The headwind that impacted Micron's topline were "continued weakness in the PC market, seasonality, and timing of product launches in other segments." This is a classic example of a correlation that does not imply causation.
Besides, for a viable business with a strong balance trading at undemanding valuations, a stock price below TBV can imply limited downside risk. Take BoA for example. The stock price is currently trading at $14.45/share, ~16% below its mean stock price target of $17.47/share. In addition, BoA's low price target is $15/share. Meaning that the company is trading below its most bearish street estimate. It is a good indication that there is less downside risk in BoA and more upside potential.
The same applies to Micron. Micron's mean analyst price target is $13.50/share, ~20% higher than its Friday closing price of ~$10.75/share. Micron's book value per share is currently at $11.89/share, approximately 10% higher than Micron's current stock price of $10.75/share. Micron's stock price has been the lowest in the last three months. The stock has gone from its 52-week high of $29.25/share to its 52-week low of $9.31/share. Micron's stock price has been the lowest in the last 52-weeks since February of this year.
Therefore, the idea that Micron can "breach the $10 floor in the coming months" is not impossible. It is just less likely. And if it does, it will be temporary. The major catalyst for the company will come from its cost-savings due to the production of DRAM's on 20nm nodes. Enabling the company to be competitive on price and increasing its chances of expanding its market share.
- Response #3: Micron's debt burden has a current ratio of 2.11. Meaning it can cover its debt obligations without any default risk. In addition, its $5.1 billion in cash and marketable investments, implies that it has enough liquidity to cover interest payments moving forward.
Quoted bear argument raised: "The market also is worried about the expensive $1.25 billion debt offering at 7.5%, which will eat into future earnings. Investors were shocked to see the debt being raised at such a high rate given that there is abundance of cheap capital."
Yahoo! Finance puts Micron's total debt as of the Most Recent Quarter ("MRQ') at $7.42 billion. Total cash ,as of the MRQ, at $3.64 billion. And Micron said that it ended Q2 2016 with cash and marketable investments of ~$5.1 billion.
"The Company generated operating cash flow of $763 million during the second quarter and we ended the quarter with cash and marketable investments of approximately $5.1 billion." - Ernie Maddock, Micron's Q2 2016 earnings call transcrip
It is because of Micron's liquidity, the low interest environment and the viability of its business, that makes its total debt less worrisome.
In addition, Micron's current ratio is 2.11. Meaning that Micron has a higher proportion of assets relative to the value of its liabilities. Implying that Micron is in good financial health because of its ability to cover short and long-term obligations.
Current ratio is not a perfect gauge but it is a good indication that Micron has the ability to pay back its liabilities (debt and accounts payable) with its assets (in this case only cash and marketable securities but to make it more compelling we can include inventory and accounts receivable).
There is more upside potential to Micron than downside risk.
First, the declining in DRAM prices is already reflected in Micron's stock price. Second, as Micron ramps up its 20-nanometer technology, it will stop intentionally reducing PC DRAM sales. Thus, Micron will be able to benefit from top-line growth due to increased volume. It will also be able to grab some market share as it becomes more cost effective.
Third, Micron is currently trading at ~26% below the street's mean price target for the stock. More so, the stock is currently trading at ~13% above its 52-week low but 63% below its 52-week high of $29.25/share.
Fourth, its current ratio and ~$5.1 billion in cash and marketable securities speaks to the company's ability to cover both short and long-term obligations without default risk.
It is the sum of the aforementioned bull factors, that makes me believe that there is more upside potential in Micron's stock price than there is downside risk.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MU over the next 72 hours.
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.