Micron: My $35 Price Target Is Looking Conservative

| About: Micron Technology (MU)
This article is now exclusive for PRO subscribers.


With preannounced earnings solidly in the upper range of revenue and the bottom line well above guidance and consensus, Micron looks undervalued.

Guidance for the next quarter and the rest of the year is key to bring Micron higher.

My $35 price target is likely conservative and with a potential 36% upside risk is diminishing as gross margins grow stronger.

Since I last wrote on Micron (MU) quite a bit of validation with regards to my thesis has occurred. But, validation alone is nothing to be excited about. If my thesis was validated but the stock didn't blink, then it really is for nothing. I mean we're here to profit and make money as the market moves to and fro.

However, this isn't the case.

When I wrote my last article Micron had just turned the corner. I contended this was just beginning of its rally - both in its business and its stock. My thesis was not only validated but the stock has since responded positively.

But I'm not here to talk about how some article I wrote came to fruition - how would that help you now (other than following me now for future ideas)? No, I want you to know MU has more to go - about 36% more to go.

What has primarily driven the stock up over 11% since it reported earnings in late December is the continued positive outlook (for companies like Micron) in memory prices. This has given management the ability to confirm the high end of raised guidance with a strong outlook for the year.

Moreover, earnings per share guidance has been vastly bumped - over 36% actually - from a mid-point of $0.63 to $0.86. This has been helped by - you guessed it - strong gross margins. In fact, the preannounced earnings are calling for a 37.5% gross margin.

The reason I point this out is because just a few short months ago the company was looking at compressed margins in the high teens. Contributors like Shock Exchange were skeptical and needed to see margins improve before giving their blessing. Now, with gross margins expected to come in at the second highest in the last three years, it's clearly time to put Micron on your buy list.

"But", you say, "this is already priced in."

I'm not so sure it is.

Guidance has been critical in sending Micron's stock up during its earnings calls. So, as we head into another earnings report, management must continue with the impressive guidance, just as they did last call. This is the one string the stock will move on. If guidance is in-line - which would still be impressive because 18 analysts have raised estimates for the current quarter in the last 30 days (March 2nd was the preannounced earnings) - the stock won't move too much. As you assumed, this is priced in already.

The way the stock will move toward my $35 price target is from strong guidance for next quarter and the rest of the fiscal year. We know management has affirmed momentum into FQ3 but using an analyst meeting as insight, it is clear management is very much conservative.

Discussing DRAM, Ho said, "...combined with a more diverse set of end markets, the company expects to see much less volatility than previous cycles. For business planning purposes, MU does not expect DRAM prices to increase in 2H17/2018, but noting that even a 10-20% ASP decline per year is very good news for a memory business given continued cost improvements."

On its face this sounds bearish because muted DRAM prices is not favorable for the company. Higher DRAM prices generally translate to higher revenues. However, the key words in this quote are business planning purposes. Management is clearly taking a conservative approach on the business planning side in order to account for fluctuations in spot and contract memory pricing - even while memory prices climb. And even if revenue doesn't increase dramatically gross margins are now driving the bottom line exponentially.

If this is any indication of management's methodology for guidance, then there is likely more upside as we draw closer to the end of the fiscal year. When I formulated my $35 target in my last article I had this to say about the upward market cycle:

This latest number lines up with the healthy margins of a Micron headed toward a bullish DRAM and NAND market. Now this is still a far cry from the days of 35% margins at the top of the cycle, however, the key takeaway is it shows us we are at the beginning of a new market upturn.

Apparently this far cry was only three months away. With expectations for 37.5% gross margins, we may be set to see a higher top than the last cycle as prices and demand still have momentum behind them. When MU was last trading for ~$34 it had just announced fiscal 2014 numbers and net income per share of $2.54. This translates to a 13.4 price-to-earnings ratio.

Today, analysts expect Micron on average to report $3.02 per share. This means a 13.4 P/E equals a $40 share price. Similarly, this means MU trades for a forward P/E of 8.5. This is well above my $35 price target but I'd rather be conservative with Micron as there are still some unknowns as far as memory pricing. Though with the Inotera deal built in this year there could be some great margins as cost savings will play an even bigger part of its bottom line. Likewise, management has been executing well to ride this upturn in memory demand so risk is evaporating as results come in and operational efficiencies are realized.

My focus will be on guidance during tomorrow's earnings release. This will tell us where MU is headed in the next few months. With the information we have, the high gross margins coming online at a rapid pace, and the memory market staying in demand, Micron has room to run. From my analysis there is at least 36% to run but if it is valued anywhere near where it was in the past then $35 could be very conservative. Who knows, I may have to bump my target if $3.02 in EPS for the year is on the low end. For now I continue to hold my shares long-term unless something unforeseen occurs in the memory market.

If you'd like to be made aware of my opinion and analysis in the future on Micron, along with other tech and semiconductor companies, then I encourage you to follow me by clicking the "Follow" link at the top of this page next to my name.

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.