Micron Earnings Preview: DRAM Giant In Sweet Spot Of Cycle, But Know What You Own

| About: Micron Technology (MU)

Summary

If this is typical cycle, investors are in 6th or 7th inning of an upcycle.

Looking at last cycle, gross margin peaked in the mid-30%'s, operating margin in the low 20%'s range.

The valuation metrics look the cheapest and most attractive at the top of the cycle.

Micron Technology (NASDAQ:MU), the DRAM and NAND semiconductor manufacturing giant, reports its fiscal Q2 '17 financial results after the bell on Thursday, March 23rd, 2017.

Street analyst consensus per Thomson Reuters I/B/E/S is expecting $0.84 in earnings per share on $4.6 billion in revenue for expected year over year (y/y) growth of 58% in revenue and, well, a lot in earnings per share (EPS) given the $0.05 loss in the February '16 quarter.

Coming out of the November '16 quarter reported in late December '16, the consensus was for $0.60 in EPS on $4.4 billion in revenue for the DRAM giant, but that was made moot when Micron management pre-announced positive results in early March '17, as fellow Seeking Alpha contributor Electric Phred detailed here in this article.

Phred does a nice job detailing the analyst consensus miss on MU, but no disrespect to Phred, as Tommy Lee Jones told Harrison Ford in "The Fugitive" when Dr. Kimble told Tommy Lee Jones, the Federal Marshall pursuing the Doctor, "I didn't kill my wife", Jones replied, "I don't care".

My job as investor is to make money for clients, in a tax-efficient, lower-turnover, long-term wealth creation manner, and to do that with Micron, you have to play the DRAM cycle - and therein lies the rub.

In other words, I care far less about the absolute level of Micron's estimates, but rather, their trend over time and the degree of the positive and/or negative revisions.

The fact is - as someone who has followed the company fundamentally since the mid 1990s (with the Excel spreadsheet to prove it, which at one time may have been a Lotus 1-2-3 s/sheet) - know what you own and don't overstay the cycle.

If you are reading this article on Micron (and there are many good articles by other contributors on Seeking Alpha), understand that you own a DRAM manufacturer with a high degree of operating leverage that is subject to the incredible price compression from oversupply of the DRAM cycle and at the mercy of Samsung (OTC:SSNLF), the largest DRAM supplier as the 800 lb. gorilla in the space.

Investors always stay way too bullish on MU and the DRAM cycle far too long, and the downside is never pretty.

Here are some numbers for readers:

Q2 '17 (est.) 11/16 8/16 5/16
2019 EPS est. $3.73 $3.12 $2.51 n/a
2018 EPS est. $3.43 $2.88 $1.76 $1.50
2017 EPS est. $2.93 $2.37 $1.11 $0.60
2019 est. EPS growth 8% 8% 43%
2018 est. EPS growth 17% 22% 59% 150%
2017 est. EPS growth 4783% 3850% 1750%
2019 P/E 7(x) 7(x) 7(x)
2018 P/E 8(x) 8(x) 10(x) 8(x)
2017 P/E 9(x) 10(x) 16(x) 21(x)
2019 est. revenue ($ billions) $19.8 $18.9 $16.8 n/a
2018 est. revenue $19.2 $18.5 $15.9 $13.9
2017 est. revenue $18.2 $17.56 $14.9 $13.5
2019 est. revenue growth rate 3% 2% 5% n/a
2018 est. revenue growth rate 5% 5% 7% 3%
2017 est. revenue growth rate 48% 42% 21% 10%

(Source: Thomson Reuters I/B/E/S consensus estimates as of 3/17/17)

Thoughts for readers: note the 500% increase in the fiscal '17 consensus estimate from May 2016 through the current February 2017 estimate. That is an absolute increase from $0.60 to almost $3 per share in just the last 12 months.

The expected revenue increase is almost $5 billion, from $13.5 to what will probably be $18.5 billion for fiscal '17 when all done.

If you think I'm fabricating or exaggerating the damage a down cycle can do in then DRAM space, here is a chronological recap of the Street estimates for MU:

FY '16 EPS est. EPS consensus # of estimates
8 /16 q4 $0.06 27
5/16 q3 ($0.04) 28
2/16 q2 $0.14 33
11/15 q1 $0.54 35
8/15 q4 $1.53 37
5/15 q3 $2.89 37
2/15 q2 $3.78 31
11/14 q1 $4.23 25
8/14 q4 $4.04 20
5/14 q3 $3.48 9
2/14 q2 $2.92 6
11/13 q1 $2.68 7
8/13 q4 $2.33 4

(Source: Thomson Reuters I/B/E/S consensus estimates after each earnings report)

The point for readers is that simply using the previous upcycle for DRAM prices and using fiscal 2016 as the target year, at one point, within 4 quarters of the start of the fiscal year, the Street consensus estimate was $4.23, and with the stock trading in the mid-$30s - MU's P/E ratio looked pretty reasonable - and yet, within 5 quarters, the consensus estimate had fallen to zero (as in no earnings per share), and the stock had fallen from the mid-$30s to $10.

Clients owned the stock during this previous upturn, buying at near $10-12 and then selling it between $24 and $26 on the way down (see chart below).

In the last DRAM cycle upturn, when MU peaked around $35 per share in late 2014, here is what its valuation metrics looked like:

  • Gross margin 33-36%
  • Operating margin: 21-23%
  • Cash flow: $5.7 billion
  • Free cash flow: $2.5 billion
  • FCF yield: 6-7%
  • P/E 10(x)
  • Forward P/E: 8(x)
  • P/Book: 3.2(x)
  • P/Sales: 2.3(x)
  • P/Cash flow: 7(x)
  • ROIC: 15-16%
  • ROE: 29-30%
  • Stock price (December '14): $35

What MU's key metrics look like today (as of fiscal q1 '17 financial results):

  • Gross margin: 25%
  • Operating mgn: 16%
  • Cash flow: $3.1 bl
  • Free cash flow: ($2.5 bl)
  • FCF yield: way negative
  • P/E: 9(x)
  • Forward P/E: 8(x)
  • P/Book: 2.04(x)
  • P/Sales: 1.93(x)
  • P/Cash flow: 8(x)
  • ROIC: +0.3%
  • ROE: +1.75%
  • Stock price (March '17): $25

(Source: Internal valuation spreadsheet using trailing twelve-month figures and valuation calculations)

When looking at the last cycle, when the stock peaked at $35 in late December '14, gross margin has stabilized in the mid-30%'s range for several quarters prior, and the operating margin has stabilized in the low-20%'s range.

It's expected given the pronouncement that the margins will increase with the fiscal Q2 '17 results we'll hear this Thursday.

Conclusion/Summary

I've always felt "core EPS" for Micron was in or around the $2.50 area, give or take $0.50 either way, and 4-quarter trailing EPS in the last cycle peaked with the November '14 quarter at $3.43, so my own "core EPS" might be too conservative. However, it is not off by much.

Micron has made some strategic acquisitions the last 3 years, which might help a little, but I still think those who cry "It's different this time" don't understand the economics of a business with a high degree of operating leverage.

To caution readers, if you try and catch the last nickel in the stock price or try to "top-tick" your exit while you watch fundamentals, you could be sorely disappointed.

Clients own less than 1% position in the stock with a cost basis between $10 and $13 (discussed here and here), and the stock is owned mostly in IRA or pension accounts, where it can be sold with the gain without tax implications.

The average gain on the holding is 82%, and if I can get $30 for a sale price, it would be welcomed. A trade back below the 200-day moving average would trigger a complete sale, and probably before that.

The great thing about MU is that if you play the cycle and be patient, and wait for the stock to trade near or below 1(x) book value, you will always get another chance to reload the trade.

There is a lot of bullish sentiment now baked into the stock, and it could well last another quarter or two. Just be careful with Micron and know what you own.

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.

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Tagged: , Semiconductor - Memory Chips, , Earnings
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