Micron Earnings Preview: Early Or Late In The Cycle?

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About: Micron Technology Inc. (MU)
by: Brian Gilmartin, CFA
Summary

Commodity semiconductor companies have exaggerated cycles on both sides of the cycle.

Micron is seeing higher EPS and revenue revisions the last quarter, following DRAM price trends.

The table below shows the operating leverage in Micron's model - its is painful - know what you own.

Micron (NASDAQ:MU), the DRAM and NAND flash semiconductor manufacturer, reports its fiscal Q1 '17 financial results after the closing bell on Wednesday, December 21, '16.

Consensus Street estimates are looking for $0.28 in earnings per share (vs. $0.24 last year) on $3.95 billion in revenue ($3.35 billion last year), for expected year-over-year growth of 17% and 18% respectively.

This will be the first quarter of y/y revenue growth for MU since February '15, and that was just 1%.

For fiscal 2017, ending August, 2017, the consensus EPS and revenue estimates of $1.63 in earnings per share on $16.1 billion in revenue have seen sharp, upward revisions. (See Table 1).

After writing about MU here, here and here, given the volatility around the stock and its difficulty in trading, the position never grew to more than 1% in client accounts although the return this year approximately is 68%, from January 1, '16 to December 17, '16.

The way to trade the stock for those that can stomach it, is to wait until the sentiment is absolutely horrid around the name, and then begin selling it, when the analyst community turns resoundingly bullish.

It is clear the commodity semiconductor giant is in the sweet spot of the up cycle. The question remains though "How long does this cycle last?"

In the last cycle, MU traded from $5 to $35, from late 2012 to late 2014 (see chart below), and investors heard that "the cycle was different this time", supply would be constrained, the manufacturers were more disciplined, etc. all of which came apart in 2014 as the stock fell from $35 back to $10.

My point is not to be unduly pessimistic or optimistic around MU's prospects, just know what you own, know how it trades, and the downside risk.

All this being said, I do think MU has more upside based on the typical DRAM/NAND cycle, BUT, when I look at Micron over the last 20 years (and I've followed the company and the stock that long), the stock is not too far from being fully valued based on a "core earnings per share" valuation in the mid $20's.

Table 1: MU expected EPS and revenue growth

11/16 est 8/16 5/16 2/16
'19 EPS est $2.62 $2.51
'18 EPS est $2.09 $1.76 $1.50 $0.99
'17 EPS est $1.63 $1.11 $0.60 $0.84
2019 est EPS gro 25% 43%
2018 est EPS gro 28% 59% 150% 18%
2017 est EPS gro a lot a lot a lot a lot
2019 P.E 8(x) 7(x)
2018 P.E 10(x) 10(x) 8(x) 11(x)
2017 P.E 13(x) 16(x) 21(x) 13(x)
2019 rev est $17.9 $16.8
2018 rev est $16.8 $15.9 $13.9 $15.3
2017 rev est $16.2 bl $14.9 bl $13.5 bl $14.7 bl
2019 est rev gro 7% 5%
2018 est rev gro 4% 7% 3% 4%
2017 est rev gro 31% 21% 10% 12%

Source: internal spreadsheet tracking consensus estimates

Fiscal 2016 EPS was a grand total of $0.06 per share on an operating basis, hence looking at 2017's EPS estimates you can see the growth off the small base.

Readers should note the upward revisions to the EPS and revenue estimates and the rapidly accelerating growth-rate estimates for fiscal 2017, which should - at least according to the consensus estimates - indicate that Micron is entering or is currently in the sweet spot of the semiconductor pricing cycle.

Here is one chart that shows the trend and the graph of the trends of recent DRAM prices. As you might expect, Micron stock has followed a similar pattern.

Table 2: Cycle's impact on Micron financials:

Readers need to see how levered Micron's business model is to the highs and lows of the commodity semiconductor cycle and what the cycle volatility does to returns. If we assume the last up cycle ended in late 2014, and the latest down cycle hits its nadir sometime in the summer of 2016, here are some financial metrics that show the leverage of the business to the commodity DRAM and NAND price swings:

Trough 8/16 Peak 11/14
TTM rev's $12.4 bl $16.9 bl
TTM EPS $0.06 $3.43
TTM Cash-flow $3.2 bl $5.8 bl
TTM free-cash ($2.7) bl $2.5 bl
Capex % of Cash-flow 184% 58%
R-O-I-C -1% 16%
Gross Margin 18% 35.8%
Operating Margin -1% 23.7%
  • Source: internal valuation spreadsheet
  • ROIC: return on invested capital (my calculation)

Readers should note the change in EPS for the given change in revenue (known as operating leverage) and also note how "capex" remains somewhat constant for Micron even with the volatility of cash-flow.

In the late 1990's, early 2000's Micron was known as a "serial capital destroyer" by the investment community because capex would exceed cash-flow-from-operations for Micron, sometimes for long periods of time, sending the stock to single-digit levels for extended periods.

From a "strategic competitive advantage' standpoint, my own sense is that Micron is still slave to Samsung's willingness and ability to overwhelm the market with DRAM and NAND production, thus Micron, although making acquisitions to diversify and stabilize the cycles, still has no "competitive moat" per Morningstar, and thus can get run over when the competition runs the manufacturing facilities full bore.

Valuation

From a trading standpoint, the most important aspect to Micron's fundamentals currently is the upward revisions to MU's 2017 and 2018 EPS and revenue estimates, and the upward trend in DRAM prices.

MU is one of your classic momentum stocks.

Trading at 13(x) 2017 earnings and 7(x) cash-flow currently, Micron is like every other "uber-cyclical" - i.e., the stock looks most attractive from a valuation standpoint near the top of the cycle, when investors and traders should be selling.

Morningstar has a "fair value" rating on the stock of $23. I've always thought that MU's "core earnings per share" over long periods of time and over a few cycles, was between $2 and $2.50 per share.

For clients, at least from a valuation and core earnings perspective, I'm a better seller of Micron in the mid to high $20's assuming there is no fundamental change in the competitive landscape.

Technical analysis:

This is the weekly chart of Micron, and you can see that Wednesday's earnings report will likely go a long way as to determining what happens with Micron around the key $20 technical level.

A strong pop in the stock on good volume Thursday and a solid close above the $20 level on good volume, and MU could run further.

Analysis / conclusion:

Given the trend in EPS and revenue estimates and my knowledge of Micron's past cycles, there is probably more upside to the DRAM/NAND cycle and to Micron's stock over the next few quarters, but I'd like to see higher revisions to fiscal 2017 estimates after Wednesday's release and analysts coming out bullish on the fiscal 2017 prospects.

A word of caution to readers though: if you wait for analysts to get you out of the stock to protect gains, you will be selling very late.

My plan currently is to exit MU probably (and things can change) in the next few quarters, and certainly by the end of fiscal 2017.

Know what you own and be careful out there.

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.