Micron Earnings Preview: 3(X) Cash-Flow Looks Tempting, But Need Evidence Of A Turn

| About: Micron Technology (MU)
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Fundamentals should start to stabilize.

Cash-Flow Valuation tempting, but free-cash-flow negative.

Micron trading very close to 1(x) book value of $11.84 per share.

Evidence of a turn in fiscal '17 and '18 is building.

Micron (NASDAQ:MU), the DRAM and NAND semiconductor giant, reports their fiscal Q3 '16 financial results after the close on Thursday, June 30, 2016.

Street consensus is expecting a loss of $0.09 per share on $2.95 billion in revenue for a year-over-year drop in revenue of 23% and, well, a hefty decline in earnings thanks to a $0.54 compare last year at this time.

Two quick points on Micron: there is a knowledgeable group of investors on the sight that follow MU regularly (see here) that I've felt always did a good job of flushing out the considerable issues on Micron and getting under the hood in terms of the industry itself.

Second, if you wait for good news on MU to buy the stock, as in the way of an earnings report or the way the Street analyst's typically operate with a herd mentality, the chances are investors can miss a considerable move.

Micron is the classic momentum stock, and I've followed it and modeled it since the late 1990's, (and gotten burned by the stock a few times, too) and you want to try and get in on it before the analysts pile in, and get out by the time the Street jumps ship.

Q3 '16 (est) Q2 '16 Q1 '16 Q4 '15
Fy '18 EPS est $1.11 $0.99 $1.59 $2.68
Fy '17 EPS est $0.94 $0.84 $1.49 $2.44
Fy '16 EPS est $0.14 $0.14 $0.54 $1.53
FY '18 EPS gro rt 18% 18% 7% 10%
Fy '17 EPS gro rt 571% 500% 176% 59%

FY '16 EPS gro rt

-95% -95% -80% -43%
FY '18 Rev est $15 bl $15.3 $15.4 $17
FY '17 Rev est $13.9 $14.7 $14.8 $16.6
FY '16 Rev est $12.48 $13.1 $13.3 $14.9
FY '18 Rev est gro rt 8% 4% 4% 3%
FY '17 Rev est gro rt 11% 12% 11% 11%
FY '16 Rev est gro rt -23% -19% -18% -8%

Source: Thomson Reuters consensus estimates after earnings reports for each quarter. For Q3 '16, Thomson Reuters consensus estimates as of June 27, 2016.

fy - fiscal year

Since Micron's recent peak in late 2014 near $35, the stock has gotten hammered as fiscal 2016's EPS estimate has fallen from a peak of $4.23 (not shown) to $0.14 today.

Yes, the fundamentals - for first time readers - are that volatile.

In last quarter's Q2 '16 conference call, Micron did say they expected their qualifications to improve through 2016. This note carried on Seeking Alpha this morning carries an important point from MKM about Samsung's production discipline. Samsung is the 800 lb gorilla in the semi space and what they do around production matters. Both are positive points for Micron over the longer-term, but as the old saying goes, I prefer to see it in the numbers.

Here is how Micron guided for the fiscal Q3:

DRAM bit growth +14%
cost / bit -8%
NAND bit growth +11%
NAND cost/bit -12%

The delta between the 2nd and 3rd quarter's is that DRAM bit growth is expected to be stronger, while NAND bit growth is expected to be weaker. (Source: conference call notes)

Margins have been crushed the last 18 months: here are the margins changes since the cycle peak in late '14:

f Q2 '16 f Q1 '15
Gross mgn 19.73% 35.82%
y/y chg -14.40%
Oper mgn -0.02% 23.7%
y/y chg -20.7%
Net mgn 0.0% 24.9%
y/y chg -22.6%
  • If the cycle bottoms with fiscal Q3 '16 reported Thursday night, the duration of the downturn lasted 7 quarters and - like MU's history - wiped out any operating or net income.
  • So there is no confusion, the Q1 '15 quarter ended Nov '14, and is not the y/y change for Q3 '16.
  • The goal was to show the margin contraction from the cycle peak

Valuation: with the stock bottoming for most of 2016, the 3(x) cash-flow and the 1(x) book value make for a compelling reason for value investors to own the stock, but Micron isn't a true value stock.

Micron's history is that through the brutal semiconductor downturns, MU destroys significant capital, as they can run for long periods without free-cash-flow generation.

The Elpida, (mobile DRAM) acquisition, made in 2013 by Micron was expected to change some of the calculus around Micron's free-cash-flow, returns, and some of the cyclicality around the commodity businesses. However, as the stock has fallen from $35 to $9 in the last two years, it looks like same old Micron.

Right now analysts are looking through fiscal 2016 and the stock could be bottoming off the improving fiscal '17 and '18 numbers.

If you look at the range of analysis estimates and the standard deviation of those estimates over time, Micron reminds me of the old brokerage stocks of the 1990's that had significant proprietary trading desks: the Street can err badly on the estimates, which is why you can see dramatic revisions up and down over a 12-month time period.

Conclusion: the stock at these levels is a better reward than risk, but expectations for the 3rd quarter are reduced and the Street isn't even expecting a profitable 90 days.

However, with qualification wins and some discipline by the other producers, I do think MU is far closer to a strong buy than a sell. The downturn looks to be ending and a DRAM/NAND upturn could be on the cusp of occurring.

If you look through the cyclicality of the stock, I think MU is capable of "core EPS" of $1.50 - $2.00, and since Micron trades with a typical 10(x) multiple, the stock has significant upside on a percentage basis. (Calculating Micron's core EPS is a struggle. The company reports an artificially-low effective tax rate which boosts EPS over the long run. Maybe core EPS is closer to $1, but "operating cash-flow per share" was $4.20 as of the Feb '16 quarter, thus MU is trading at 2.6(x) OCFPS.)

The 2014 cycle which lasted 2 years, was strong since producers remained disciplined which took MU from $5 to $35 before the cycle gave in to the economics once again.

MU was bought on Friday last week during the initial Brexit shock and has been bought (here and here) at the stock off-and-on through 2016. If you can be patient with the stock for 12 - 18 months I do think Micron is poised for another run.

If the stock trades below $9 on heavy volume, which would take out the 2016 low, the recovery is further off than expected.

Disclosure: I am/we are long MU.

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.