Micron: Ignore The Noise, And Keep Dreaming

Summary

• Micron’s CEO Sanjay Mehrotra has been a straight shooter since joining the company.
• We report the key points he made at the UBS and Credit Suisse conferences in November.
• The long-term demand is reiterated as secular, and the oversupply issue is temporary.
• Drops of hints on the DRAM and NAND oversupply situation and gross margin shows a stable business.
• The long-term vision of Micron as the only one-stop shop for storage and memory solutions is worth dreaming and waiting for.

Investment thesis

Micron (NASDAQ:MU) is an investment that does not exist in the academic world. With a unique mix of products, a world-class top management team and pristine fundamentals, the perception of this high intrinsic value should be reflected in an equally high price tag. Yet, we find this stock trading at less than 4x PE. Maybe the market is inefficient after all.

We have never felt easily convinced of an investment such as Micron. Mr. Market has knocked on our door, and we have said yes to the price so many times that we have accumulated enough shares to make it the biggest position in our portfolio.

Confirmation bias or not, we feel compelled to report the facts that CEO Sanjay Mehrotra has presented at the recent UBS and Credit Suisse Technology conferences. The numbers and the vision that Sanjay presented make total sense for us. Let’s go through one by one.

For reference, please read the transcripts provided here: UBS Global Technology, and Credit Suisse Technology.

Q1-2019 revenue and EPS will be within guidance

We wished that Sanjay had not announced the FQ1 revenue and EPS numbers. Had he kept his silence, the figures would create a more considerable surprise to the market at the actual earnings results day. Nevertheless, the facts are out, and investors can still invest in Micron at a wonderful price, albeit at a slightly higher price, trading for higher certainty.

As a reminder, as at Q4-18, the forward Q1-19 guidance was:

• Revenue: $7.9B and $8.3B,
• EPS:$2.87 and $3.02.

Sanjay announced that Micron’s revenue will achieve the lower end of guidance, roughly $7.9B, and EPS will be at the higher end of the guidance, at $2.95 plus. Great results here!

Demand trend is secular and stable

Sanjay reminded investors that the demand is solid, and the end market needs will be higher across all products.

Source: MU - 2018 10-K

The higher demand for the first four segments will be largely driven by AI, machine learning, applications and smartphones and data centers and cloud, and IoT.

Some of the examples that the CEO gave were: First, the Tier 1 phone companies are pushing storage from 32GB to 64GB, then to 256GB and even 512GB as a greater percentage of their product mix. In data centers, he saw high demand in NAND Flash as it has many advantages such as lower power consumption, lower defectivity and failure rate. We can also cross-check with the increased demand in the earnings call from Microsoft’s Azure (MSFT) or SK Hynix (OTC:HXSCF) (OTC:HXSCL) just to name a few.

As for the last segment, embedded business unit (EBU), the CEO affirmed that it is a unique segment in that the solutions have a longer life cycle of 7-10 years. Additionally, the peak and trough prices do not have a large gap such as the other segments. In other words, this segment is the least ‘cyclical’ of the bunch. Thus, with higher predictability, this segment should be worth a lot more than 4x P/E.

Oversupply is temporary

For the fiscal year 2019, the supply of DRAM is expected to grow by 20% and NAND by 35-40%. However, we have learned from the conferences that the oversupply situation will improve in the second half of the year. There are external and internal justifications.

Externally, the oversupply caused by CPU shortages as well as the inventory adjustment in the previous quarters would be minimal by H2 of 2019. Additionally, the CAPEX cuts that have been happening across the industry will also relieve some of the overcapacity.

Internally, in the long run, Micron’s CAPEX will be kept at around 30% of sales. The level ensures that investment in capacity will be sensible. For 2019, CAPEX will be $2.5B higher than the amount in 2018. The important information here is that this incremental increase will not go toward expanding supply. In Sanjay’s words:

So that $2.5 billion doesn’t go toward any big growth per se, it’s really going toward building the shell and the rest is going toward equipment CapEx that ultimately drives the supply bit growth. So we look at CapEx absolutely from an ROI point of view actually any part of our OpEx and CapEx we are extremely focused on looking at it from ROI point of view.

Source: Sanjay Mehrotra, CEO, Credit Suisse Annual Tech Conference

Additionally, CAPEX in NAND will be lower in 2019:

So, if you look at our equipment CapEx, it is actually down in NAND year-on-year in fiscal 2019.

Source: Sanjay Mehrotra, CEO, UBS Annual Tech Conference

Overall, we are comfortable that the oversupply issue is temporary. Coupled with the positive demand trend, the economics for the industry are not that depressed as the share price implies.

How will gross margin be?

As a result of the secular demand growth and temporary oversupply issue, profitability levels of DRAM and NAND are expected to be on the strong side by the end of 2019. What Sanjay meant by strong side is that in comparison with the historically standard, gross margin will be substantially higher.

Stepping back 15 years leading up to 2015, DRAM average gross margin was at 20%. It rose to 56% in 2017, and then up again to 70% in 2018. The margin expansion was incredibly impressive. Sanjay explained that although we are experiencing a period of margin contraction, the figure for 2019 will be significantly higher than previous cycles at 20%.

Why is this time different? Simply, in DRAM, the industry has been consolidated to just three major players. As a result, the economic decisions of players are more rational. Secondly, Micron has also been focusing on higher value product mix such as SSD. While we don’t want to guess what the gross margin of DRAM will be for 2019, we are comfortable that it won’t be at 20%.

In NAND, the situation looks more precarious. The biggest reason is that the industry has a higher number of competitors, six instead of three. Nevertheless, NAND gross margin was still at a respectable rate, at 47% in Q4. Sanjay also revealed that the rate would improve going into 2019 as Micron has been rapidly transitioning to higher value solutions. The figures he gave were impressive. Four years ago, Micron went from selling 80% of NAND as components to now at just 40%. Thus, at the moment 60% of NAND products are higher margin. The goal in 2021 is to revert the 80% from low-value to high-value solutions.

Again, we can't guess what the precise gross margin will be for 2019. From the information above, we are comfortable that DRAM and NAND margins are not depressed. However, if we have to guess, it would still be above 50%.

Long-term dream

We invested in Micron for the long term. Currently, Micron is already a player that can provide solutions in both DRAM and NAND. Launching 3D Xpoint solutions by the end of 2019, it would become the only full-stack provider of storage and memory in the industry. This unique position makes the investment in Micron incredibly attractive for long-term investors. We invest and wait, forgoing the short-term volatility for substantial long-term reward.

Takeaways

To conclude, we found the information from the two conferences incredibly bullish. In Sanjay Mehrotra, we have an incredibly capable CEO. He has done it at SanDisk and now despite the down-cycle and joining the company just over a year ago, he seems to have skipped the transition period and gone straight to directing the company to higher land.

In this challenging period, he remained focused on ROI in all decisions, closing the cost gap with the industry, allocating capital to buy back shares at a reasonable price, cautiously increase CAPEX and capping long-term Capex, and making a strategic JV with Intel (INTC) to differentiate the product offerings.

In such a short period, he also managed to execute 90% of the plan to mitigate higher tariffs. Last but not least, he also successfully planted a dream that soon Micron will be the only player in the industry that can provide a complete solution for storage and memory.

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Analyst’s 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.