Micron: The Bright Side Of The DRAM Glut

| About: Micron Technology (MU)


The 2015 DRAM glut reduced earnings and stock price significantly.

The same glut increased demand more than any marketing could.

Samsung's reduction of DRAM manufacturing should reduce the glut and provide for a more profitable sales environment.

Micron (NASDAQ:MU) has had a tough year overall. The Samsung led DRAM glut had left the company scrambling to break even as the selling price of its primary earner ("Sales of DRAM products were 58%, 64%, and 68% of our total net sales in 2016 , 2015 , and 2014 , respectively" according to their 10-K) dropped way faster than its cost to produce. While selling price dropped 35% in 2016 vs 2015, production price only decreased 17%. This made it incredibly hard to make a profit. Due to this, the stock price plummeted over the last couple years.

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After their fourth quarter report however, we have seen a swift rebound in stock price. What I want to explore is whether this is reasonable. Are the bulls correct in their sentiment? I believe that they are not only correct, but they have more room to go. The marketplace is improving for the company in significant ways and that will bring the company back to its former glory, maybe even reaching its high of over $35.

While the depression in DRAM prices may have hurt not only the company's earnings, but also its stock price, I believe it provided the perfect investment opportunity. While the market focused on the company's lack of earnings, everyone ignored its potential increase in demand. The glut in DRAM allowed for PC manufacturers to add large amounts of DRAM inexpensively, thus increasing demand. This increased demand, while at lower margins, is enough to make up for the lost profit from the glut.

At this point, due to the reduced prices of DRAM, it has become standard practice in almost every device. As DRAM prices rebound, or even flatten out, the market is stuck being reliant on it. The beautiful thing about innovation is that nobody is willing to move backward. This means that the while the Samsung glut hurt stock prices and profits short term, it entirely worked as a means of increasing demand. While the glut hurt stock prices overall, it was essential in ensuring that DRAM was widely adopted and demand growth increased rapidly.

Fortunately for Micron, Samsung has decided to focus their efforts on NAND technology and reduce their spending on DRAM. While this might spell long-term changes in market relevance of Micron's primary earning vehicle, it should help with profits short-term. The decreased supply should help elevate prices back to a more lucrative price and thus help with the bottom line significantly.

This increased demand on DRAM products is what allowed Micron to declare an expected non GAAP income of $335 Million for next year despite failing to break even this year. The company expects an increased demand of 20-25% while only expecting the supply growth of 15-20%. I believe these numbers to be modest due to the ubiquitous usage of DRAM in every cell phone and computer sold. When this increased demand is coupled with Samsung's decision to reduce DRAM manufacturing, a profitable year is in store for Micron and they know it. I suggest getting in before the rest of the market realizes as well.

As I end many of my articles, I like to analyze market sentiment using Option Greeks to decide whether the timing is good for investment. To do this I look at Option Greeks over the next month which show implied probabilities of hitting certain stock prices. At its current price, a stock price increase of 5% is considered 23% likely while a 5% decrease is only 18% likely. Clearly the market has short term positive expectations. In the long term (July 2017 expiration) as well the market sees the same increase/decrease at a 49.7% vs 34.3% ratio.

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.