What To Do With Shares Of Micron Technology

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About: Micron Technology Inc. (MU)
by: Mark Bern, CFA
Summary

Quantitative Analysis of Micron Technology shares using the power of free cash flow.

Analysis of Micron Technology from a Main Street vs. Wall Street perspective.

Shows the reader how to do a similar analysis on their own portfolio holdings.

If you own shares of Micron Technology (MU), you may be wondering what to do with those shares. I had a subscriber to our MarketPlace offering, Friedrich Global Research, ask me that question. I would assume that there are a lot of readers on Seeking Alpha asking that question, so I decided to write an article in order to help as many people as I can at one time.

Some of you will recall that I used MU put options for hedging in a series of articles from 2014 through 2016. Those MU puts made decent gains during 2015 because the company was still very sensitive to the price gyrations of its commodity-like memory chip business. Notice how much the stock dropped at the end of that cycle (from over $36 to less than $10).

Source: Yahoo! Finance

At some point in 2016, Micron management made a pivot to improve the ASP (average selling price) by increasingly adding higher value products to its mix. That strategy caused me to rethink my use of Micron as a candidate for my hedging strategy. I decided to drop it. But, here we are again.

Source: Yahoo! Finance

From a high over $64 to a low under $29 in just over six months. Perhaps the cycle is not completely dead after all. But one thing I am convinced of is that Micron is much more capable of rebounding and providing long-term growth than in previous cycles. I will explain this later in the article.

Micron stock was doing just fine until something new came about: a trade war with China. China buys a lot of MU’s products as components that go into a wide array of electronic equipment that Chinese manufacturers then sell domestically within China and export worldwide, especially to the U.S.

The tariffs created worries, especially for Micron’s Chinese customers. The current slowdown in sales is reportedly due to a glut of inventory in the supply chain of MU customers. Assuming that Chinese customers stocked up on MU components ahead of tariffs initially being imposed, that would make sense. Now, we just need to wait until that inventory stock is worked through to more normal levels (one to two quarters) and for negotiations between China and the U.S. to be resolved positively and MU stock could actually rebound very nicely. But there is a big “if” in there.

On January 9, 2019, Seeking Alpha's Senior News Editor Brady Betz reported this: "Micron +3% on upgrade for faster recover (update).” The gist of the news was that Micron shares now offer a better value than when priced above $60. Duh!

There are plenty of articles on Seeking Alpha that will explain how much Micron has transformed its business model. I like this one, which is somewhat dated, but there are plenty of other articles explaining the pros and cons of what the company is up to from an operations and market standpoint.

What I want to do is to provide an analysis of Micron’s FCF (free cash flow) and how we use it to determine how efficiently the company is operating as well as how the stock is valued by Wall Street. Remember: a company may have excellent management and generate superior results but it is not a bargain at any price.

Main Street Vs. Wall Street

In analyzing Micron Technology, we will present some unique ratios that our Friedrich Investing System uses and will present a real-time quantitative analysis that will demonstrate the power of free cash flow in the investment process. We hope that this example and explanation will enable readers to analyze portfolio holdings of their own using our methodology. At the same time, we will explain how the methodology involved in this analysis came about.

Main Street is where Micron operates and Wall Street is where its shares trade. The Micron shares are available for purchase on Wall Street in the public domain, and the company has little control over its share price in the short term.

Benjamin Graham, said to be the father of value investing, was attributed with credit for one of my favorite quotes, “In the short run, the market is a voting machine but in the long run it is a weighing machine.”

Micron Technology is required to release earnings reports each quarter and from time to time, it also provides press releases to its shareholders (and the general public) giving updates on how its operations are doing on Main Street.

Main Street is where Micron Technology invests in its own operations and sells to its customers. How well the CEO of Micron Technology and its management do in selling those products determines how profitable the company will be. Wall Street then reacts based on the success or failure of management to meet its goals. Main Street and Wall Street are thus interlinked, but because anyone with a computer (or even just a smartphone), an internet connection, and a brokerage account can buy or sell any stock at any time, expertise is not a requirement in order to invest on Wall Street.

This results in Wall Street being a very dangerous place to operate as many investors tend to invest through emotion or tend to follow the herd in and out of stocks. During bull markets, investors feel like they can do no wrong as "the rising tide lifts all boats." But when a bear market suddenly shows up, these same investors tend to panic like lemmings stampeding over the cliff. Thus, we have the classic case of "greed vs. panic."

Creation Of The Friedrich Algorithm

Having noticed this problem some 30 years ago, Mycroft spent the last three decades building an algorithm called Friedrich. Our algorithm was designed to assist all investors (both Pro and Novice alike) and give them the ability to quickly compare a company's Main Street operations, to its Wall Street valuation (Overbought or Oversold condition). Friedrich can do this on an individual company basis or assist users in analyzing an entire index like the S&P 500, an ETF, Mutual Fund, or individual portfolio with the use of our Portfolio Analyzer. We recently did so when we compared Apple (AAPL) to the S&P 500 Index (SPY) Apple Vs. The S&P 500: Which Is The Better Investment?

Many years ago, while reading Berkshire Hathaway's (BRK.A) (BRK.B) 1986 letter to shareholders, Mycroft discovered a ratio, which Mr. Buffett entitled "Owner Earnings," or what we may consider to be Mr. Buffett's version of "Free Cash Flow." Amazingly, in that little footnote, Mr. Buffett explained how to use it and states that it is one of the key ratios that he and Charlie Munger used in analyzing stocks. In that article, he defined the term "owner earnings" as the cash that is generated by the company's business operations.

"[Owner earnings] represent [A] reported earnings plus [B] depreciation, depletion, amortization, and certain other non-cash charges… less [C] the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume."

We have used this free cash flow ratio for decades, using data from the Value Line Investment Survey, whose founder was Arnold Bernhard. Mr. Bernhard was a big fan of free cash flow and probably introduced it sooner than Mr. Buffett did. We know this as Mycroft was able to calculate the FCF ratio using old Value Line's sheets for his 60-year backtest of the DJIA from 1950 to 2009.

In the backtest mentioned above, Mycroft demonstrated that if one can purchase a company whose shares are selling for 15 times or less its Price to Free Cash Flow Ratio that the probability of success will dramatically increase in most cases. He has renamed the ratio the Bernhard Buffett Free Cash Flow ratio in honor of both men. The following is how that ratio is calculated.

Wall Street Analysis

Price to Bernhard Buffett Free Cash Flow Ratio = Sherlock Debt Divisor / [(net income per share + depreciation per share) - (capital spending per diluted share)]

Sherlock Debt Divisor = Market Price Per Share - ((Working Capital - Long-Term Debt)/Diluted Shares Outstanding)

The above are the ratios used when analyzing a stock on Wall Street, and below are the ratios we use when analyzing a stock on Main Street.

Main Street Analysis

FROIC means "Free Cash Flow Return on Invested Capital"

Forward Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) - (Capital Spending)]

FROIC = (Forward Free Cash Flow)/(Long-Term Debt + Shareholders' Equity)

What the FROIC ratio does is tell us how much forward free cash flow we can expect the company to generate on Main Street relative to how much total capital it has employed. So, if a company invests $100 in total capital on Main Street and generates $20 in forward free cash flow, it, therefore, has a FROIC of 20%, which we consider excellent. This is just one of the key ratios (66 in total) that we use to identify how a company is performing on Main Street, as it is our belief that if a company is making a killing on Main Street that this news will eventually show up on Wall Street's radar.

So, let us begin our analysis and at the same time try to demonstrate how to do a similar analysis on one's own portfolio. In analyzing Micron's Price to Bernhard Buffett FCF ratio, we must first analyze Micron’s Sherlock Debt Divisor. Here is a detailed definition of what that ratio is:

Sherlock Debt Divisor

A major concern that we have these days in analyzing companies is the amount of debt each has on its balance sheet relative to its operations and whether management is abusing this situation by taking on more debt than it requires. Debt, when used wisely, allows for what is called leverage, and leverage can be extremely beneficial within certain parameters. On the other side of the coin, the use of debt can also be excessive and put a company's future in jeopardy. So, what we use to determine if a company's debt policy is beneficial or abusive is our Sherlock Debt Divisor.

What the Divisor does is punish companies that use debt unwisely and rewards those who successfully use debt as beneficial leverage. How do we do this?

Well, we take a company's working capital and subtract its long-term debt. If a company has a lot more working capital than long-term debt, we reward it, but punish those whose long-term debt exceeds its working capital. It works as a sliding scale so that the punishment varies from little to great depending on the level of excess.

So, if the result is higher than the current stock market price, then leverage is being used and the more leveraged a company is, the worse the results of this ratio will be and the less attractive we consider its stock to be as an investment.

Thus, having successfully defined the Sherlock Debt Divisor, we need the following four bits of financial data in order to calculate it for Micron Technology. TTM (trailing 12 months) is as close to real-time data as we can get, based on when each company reports without making assumptions.

Market Price Per Share = $36.01

Working Capital = Total Current Assets - Total Current Liabilities

Total Current Assets = $15,040,000,000

Total Current Liabilities = $5,190,000,000

Working Capital = $9,850,000,000

Long-Term Debt = $3,730,000,000

Diluted Shares Outstanding = 1,130,000,000 (increased by 20 million shares since 2017)

Sherlock Debt Divisor = Market Price Per Share - ((Working Capital - Long-Term Debt)/(Diluted Shares Outstanding))

Sherlock Debt Divisor = $36.01 - (($9,850,000,000 - $3,730,000,000)/ 1,130,000,000))

Sherlock Debt Divisor = $36.01 - $5.42 = $30.59

Since Micron Technology has less Long-Term Debt vs. Working Capital, we, therefore, reward it and use the new $30.59 as our new numerator in all our calculations.

Wall Street Analysis of Micron Technology

Price to Bernhard Buffett FCF Ratio = Sherlock Debt Divisor/[(net income per share + depreciation per share) - (capital spending per diluted share)]

Sherlock Debt Divisor = $30.59

Net Income per diluted share = $14,750,000,000 / 1,130,000,000 = $13.05

Depreciation per diluted share = $5,090,000,000 / 1,130,000,000 = $4.50

Capital Spending per diluted share = $9,620,000,000 / 1,130,000,000 = $8.51

$13.05 + $4.50 - $8.51 = $9.04

Price to Bernhard Buffett Free Cash Flow Ratio = $30.59/$9.04 = 3.38

Now, if one goes to our FRIEDRICH LEGEND (on what is considered a good or bad result), you will notice that our result of 3.38 is considered excellent.

We last ran our data file for Micron Technology on January 2, 2019, and our Friedrich Algorithm gave a recommendation to our subscribers that Micron Technology is a "Strong Buy" as our Friedrich Data File and Chart below show. There you will also find the last ten years of Micron Technology's Price to Bernhard Buffett Free Cash Flow results.

Main Street Analysis of Micron Technology

Now that we have explained to everyone how to calculate our Price to Bernhard Buffett Free Cash Flow ratio, let us now move on and show everyone how to calculate our FROIC ratio.

This is how we calculate it:

FROIC means "Free Cash Flow Return on Invested Capital"

Forward Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) - (Capital Spending)]

FROIC = (Forward Free Cash Flow)/(Long-Term Debt + Shareholders' Equity)

Net Income per diluted share = $13.05

Depreciation per diluted share = $4.50

Capital Spending per diluted share = $8.51

Revenue Growth Rate TTM = 3.6%

[(($13.05 + $4.50) (1.036%)) - ($8.51) = $9.67

Long-Term Debt = $3,730,000,000

Shareholders Equity = $33,870,000,000

Diluted Shares Outstanding = 1,130,000,000

FROIC = (Forward Free Cash Flow)/ (Long-Term Debt + Shareholders' Equity)

$9.67 / $33.27 = 29.1%

FROIC = 29.1%

Now, if one goes to our FRIEDRICH LEGEND again (on what is considered a good or bad result), you will notice that our result of 29.1% is an excellent result and tells us that Micron Technology on Main Street generates $29.10 in forward free cash flow for every $100 it invests in total capital employed.

In previous cycles, Micron’s FROIC would have tumbled to a negative number as it would be burning cash. Its improved ASP and higher value product mix appears to have made a significant difference this time, so far at least. The true test will be whether or not a recession hits. But the company is in far better shape now than in the past when inventory overhang had demolished the memory industry.

On Main Street, Micron Technology is doing excellent, while on Wall Street it is a bargain. Now, if one can build a portfolio with stocks like Micron Technology with excellent Main Street results and buy all at attractive Price to Bernhard Buffett Free Cash Flow ratio results, then your portfolio should be a star on both Main Street and Wall Street. Finding companies that have excellent results on Main Street and Wall Street (simultaneously) these days is, unfortunately, like trying to find a needle in a haystack.

What To Do?

Going forward, you will notice that for the Main Street price in our Datafile for Micron Technology above, we assigned it a $197.31 result. That may not be an attainable price target in the next 12 months but it can be taken to mean that Friedrich considers Micron shares to be very oversold and a great bargain for long-term investors at the current price.

In conclusion, it is our belief that free cash flow analysis is the ultimate tool when analyzing companies, and it is our hope that you may add these ratios to your own investor toolbox to help you in your own due diligence. If you have any questions, please feel free to ask them in the comment section below.

At Friedrich Global Research, we stick to the numbers. We do analysis like what you saw in this article, but for 20,000 stocks from 36 counties around the world. We also provide model portfolios ranging from ultra conservative to aggressive growth, so you can apply our research to your investing easily.

Interested? Go here to sign up today.

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.

Additional disclosure: DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from our research. Factual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.