Micron Technology: Chips Ahoy!

Summary

• For October DRAM contract prices were up an amazing 7-8%. Spot prices were up 14-17%.
• NAND contract prices were flat to up 3%, with spot up about 1%.
• DRAMeXchange's opaque mysterious DXI index continues to be up but opaque and mysterious. Some recent perturbations are examined under my low power cloudy microscope.

Like the gourmet delicacy mentioned in the title, DRAM contract pricing for October has been scrumptious and Micron Technology (NASDAQ:MU) will benefit mightily.

I'd been waiting for an update on contract prices for memory chips, as opposed to the spot market prices reported nightly on DRAMeXchange. Bernstein was the first research report I've seen with an update and they've included their usual excellent charts and commentary:

With Q4 contract price settled for tier-1 OEM, DRAM contract price rose over 7% sequentially MoM as supply shortage continues. DRAM spot prices continued to sizzle and rose over 17% for DDR3 and 14% for DDR4 in October. For NAND price, as the market moved to more balance environment, contract price for 32Gb MLC was up by 3% MoM while 64Gb and 128Gb stayed flat. Mainstream NAND spot prices were relatively stable (up 1% MoM) during October

DXI Index. I haven't seen anyone who can really make sense of DRAMexChange's DXI index from their paltry description or its squiggles; I can't either. But I track it because of its past excellent tracking with Micron's stock price.

As the calendar turned the page to November, the DXI plumeted 2.2% despite strong DRAM spot prices. Various theories have been advanced on my previous chip price article, such as a lag or a beginning of the month reset of some type. Or maybe DRAMeXchange is swapping different chip types in and out of the index at the beginning of the month? It would be nice if they told us. Here is the price action for the first day of the month for the past several months:

	1st day change	average monthly change per day
June	0%	0.38%
July	0.27%	0.44%
August	-0.07%	-0.03%
September	3.03%	0.70%
October	7.01%	0.85%
November	-2.22%

Click to enlarge

It certainly does look like some adjustments are being made the first day of each month. Who knows? Kudos to raa1144, lester98 and others on my previously cited thread who have tried to make sense of the DXI. With that "analysis" of the DXI inputs done, here's how it looks today:

May the Micron stock price catch up with the index! Call me spoiled but I like Dow Jones telling me what the 30 Industrial stocks are, what the divisor is, and when index changes are made. May both Micron and DRAMeXchange catch the transparency bug.

DRAM. Let's take a deeper dive into DRAM. Much has been made of the involvement of Sun Computer founder Bill Joy at Water Street Capital, and his role in getting a massive portion of their portfolio into Micron stock. (Lucky them!). Here's a paragraph from one of Joy's memos which concisely sets the back story for what's driving DRAM prices:

DRAM supply growth is constrained by the radical slowing of Moore's law advances as DRAM-specific scaling limits are reached. While a past shrink might have given you 50% or more bits per wafer the smaller shrinks now give only a fraction of that. As these smaller nodes require additional and expensive machines they also put upward pressure on capital costs and take additional factory floor space, pressuring existing facilities and budgets. So, in this new world, to achieve substantially more capacity additional facilities must be built. This slowing also means that existing facilities should be usable longer than in the past, a not insignificant factor which could, for example, add $1.00 per share of earnings to a vendor like Micron from reduced depreciation cost for continuing revenue. Rational, profit-maximizing behavior by the at-scale memory producers; and the incredibly high IP and cost-barriers to new, especially Chinese, vendors entering the DRAM market cause us to strongly believe that supply will fall quite short of meeting available and potential (elastic) demand.

Oh for the clarity! Oh to be concise! Oh to have Water Street's timing diving in with both feet!

And here are a couple of spot vs. contract price charts from Bernstein:

For the Micron historians out there, you will remember former Micron Investor Relations head Kipp Beddard telling us (wrongly) to ignore the spot price since Micron sells so little of its volume in the spot market. And you will remember that more recently the current Micron CFO Ernie Maddock admitting (correctly) that spot prices act like a kind of magnet for contract pricing.

And here is an update of my graph of nightly spot prices as reported on DRAMeXchange vs. the Micron stock price:

Obviously the lines have once again converged. Where will that red line be going? Upward I think.

And what about NAND? Here's Bernstein's Mark Newman in his November 1 update on chip pricing:

As market continues to trend toward balance condition due to incoming 3D NAND capacity and improved yield, the pace of NAND price increase has slowed down significantly the past quarter. Spot price for all mainstream modules rose slightly by 1% MoM. NAND supply for lower density module will be limited as suppliers continue with 3D NAND conversion and some tactical capacity shift to NOR flash to satisfy surging demand from OLED market. In Q4, we expect relatively stable price for NAND as new supply will be absorbed by the seasonal mobile demand. With the upcoming 3D NAND ramp, we expect supply constraint to be relived for higher density NAND module starting 2018.

And here is one of his charts on NAND spot vs. contract pricing:

And here is my graph of the nightly spot price of three NAND chips reported on DRAMeXchange vs. the Micron stock price:

And before readers have a heart attack looking at the crossed spot and stock price lines consider that Micron's costs are coming down rapidly, that Micron has a larger percentage of 3DNAND than its competitors, and that the Micron 3DNAND product may be performing better than that of its competitors according to some news clips and brokerage reports.

Some thoughts on hedging and trading. For me, the chip pricing story for Micron looks very much intact. But given the massive rise in Micron's stock price I am regularly writing covered calls against my positions. These are out only a week or two so I can rinse wash and repeat, and are slightly out of the money, usually a one standard deviation move above current trading price. Even with the rocket ship stock price rise and my recent magnificently poor timing of writing covered calls, I have usually been able to roll "up and out": Buy back a formerly out of the money call which is now at or in the money, and sell a new one at a higher strike price and out a week or so. But mostly I've been able to pocket the premiums from the covered calls when they expire and rinse, wash, and repeat.

For me the bigger risk for Micron, and the market in general is macro. What about a conflagration on the Korean peninsula? What about further political indictments? Further stagnation on tax reform and medical legislation? More terrorist events? Make your own list and imagine your own nightmares. So that I sleep better, I've been using some of those aforementioned covered call premiums to buy call options on the triple inverse S&P ETF the SPX. If Micron is dragged down by some massive macro event, I want at least a little protection.

Conclusions. As mentioned, I think the chip pricing part of this story is intact. The blazing DRAM spot prices saw not a single nightly downtick on the 6 chips covered by DRAMeXchange from September 6 through October 18. This is unusual, great, and not likely to happen again. As SA commenters have noted, Micron should do well in even a declining chip pricing market since costs are coming down quickly as well. The NAND side of the equation is a bit gloomier, with softness already being exhibited. For worriers on the NAND front I would remind them of the elasticity in that market: as prices come down it will stimulate more and more demand. I also believe Micron has a significant advantage here, since they have the largest portion of their NAND production already on 3-D. I think we may learn more about other Micron scaling advantages and perhaps the floating gate (Intel and Micron only) vs. charge trap (all other competitors) advantages which have been written about and hoped for.

Chip pricing is just one of the things a Micron investor should follow. Mark my prediction: DRAM spot and contract pricing are going to continue their upward march for at least a couple of quarters.

Write some covered calls. Lower your margin balances. Buy some downside protection. Do a lot of reading and research. And good luck to all!

Analyst’s Disclosure: I am/we are long MU, INTC. 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.