Micron: The Perfect Bonanza Might Be Just Around The Corner

Summary

• Memory and storage hardware producers have always been perceived as risky assets.
• The history of boom and bust in the industry seems to sustain this thesis.
• However, Micron seems to be leaving part of its cyclicality behind, even if investors don't seem to acknowledge it yet.

Micron (NASDAQ:MU) is consistently perceived as a risky stock, vulnerable to its condition of price-taker in a very aggressive industry where price cuts are the norm. However, during the last couple of quarters, the company has kept beating its numbers and consistently raising its outlook. How does one interpret this?

Data analytics, data mining and A&I are driving a trend towards huge memory consumption. This is a great opportunity for Micron. Forecasts suggest that data centers capex will increase 2.6 times until 2021.

Graph 1: Cloud data center capex forecast 2017-2021

(Source: Micron)

As you can see, the density of memory is also increasing, with AI workloads demanding 6 times more DRAM and 2 times more SSD when compared with a standard cloud server. On the supply side, it is getting increasingly harder to grow due to the complexity of the technology, meaning that producers will need more clean room space.

Graph 2: NAND Bit Supply growth

(Source: Micron)

The trends are a-changing

A couple of years ago, overcapacity was the norm in the semiconductor industry. However, both semiconductor technology and new technology in other fields are changing the old ways. Artificial intelligence is driving the demand for more processing capacity and memory density. Cloud applications are becoming more and more adopted. Companies are keener to rent a server on the web instead of buying expensive powerful hardware that they will only use a fraction of the time.

At the same time, flash NAND and 3D NAND are unleashing new possibilities concerning the density of memory. As these two trends are meeting, a new world is emerging at a fast pace. Small companies are getting a shot at AI through rented servers, but as they grow, they are also demanding more data. At the beginning of the century, cars were responsible for a negligible amount of data. In the present, there are claims that connected cars will send a whopping 25 gigabytes to the cloud every hour.

Let me tell you that this is great! The demand for data will drive a sustainable demand for memory and DRAM. Additionally, the technology is improving at such a fast pace that NAND production cost is becoming increasingly lower and the trend toward hard drives being replaced by SSD is also gaining traction.

Micron's financial performance is already reflecting this

As these trends emerge, Micron is very well-positioned to surf this huge wave. The company is already showing positive signs in its financial results. Both earnings and revenues have grown, and this has been accompanied by higher margins.

Table 1: Micron margins 2017-2012

(Source: Micron Annual Reports)

The cyclicality is still there (2012 and 2016), but lately it has been less pronounced. If we ignore the cyclicality for a moment, we can see that the margins have been improving drastically. This is explained, in part, by the mega trend towards more data consumption, but it is also a result of good management.

From 2012 to 2017, revenues grew almost 150%, from $8 billion to $20 billion. At the same time, gross margin improved from 11.8% to more than 41%, while maintaining the relative weight of R&D costs and decreasing to half the SG&A relative weight. This reflects higher efficiency of production capacity, constant R&D efforts and higher organization efficiency. All this might be the result of tailwinds, but the extent and longevity of the progress suggests that good management was also a key factor.

Table 2: Micron SG&A and R&D as percentage of revenues 2017-2012

(Source: Micron Annual Reports)

An investment thesis for Micron

Micron's performance has improved steadily during the last couple of years. The company has become more solid as the market matured, and the huge swings in revenues and margins have smoothed significantly.

On the other hand, the environment is tremendously positive. As the internet keeps evolving, old businesses attract newcomers with new approaches. As an example, the old and boring auto industry is now at the forefront of data production and consumption. This is a sign of the times. Other industries are joining this trend as we speak.

In my opinion, this is a good time to bet on Micron. The company is already showing great ability to increase revenues and profits, while at the same time enjoying tremendous tailwinds.

The missing point here is valuation. The market is being doubtful and, therefore, hesitant to recognize Micron's improved condition. Obviously, there might be good reasons for this. For instance, the industry's past, full of pronounced cyclical swings, is a major turn-off for many investors, the majority of whom seem to be keeping their biases on.

However, when I see the adoption of cloud solutions that other companies are enjoying and the effect that this had on their stock price, I cannot avoid thinking that Micron is being overlooked. The company is fundamentally riding the same trend, only its valuation has been left behind.

This means that there is huge room for an expansion in valuation multiples. If the industry keeps growing on the tailwinds of data demand and Micron keeps track of the industry's trends, we might see a perfect storm, where great financial performance riding the data mega trend inflates the company's multiples.

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.