During the last twelve months, Micron Technology (MU) had a pretty wild ride. From the top to the bottom of the year, stock fell more than 50 percent and this price decline has opened up an opportunity to buy a growth stock at the deep value levels. From the bottom achieved at the end of December, Micron has advanced for more than 30%, but statistically and qualitatively speaking, current valuation levels still provide substantial upward potential.
Micron operates in a growth industry that should, due to the global technology trends, remain in an expansion for the foreseeable future. In the same time, this stock trades at the bottom of the US valuations and is one of the cheapest stocks in the technology and large-cap sectors.
Industry and Growth Prospects
From 2010 until the last financial report, Micron has achieved a stellar growth of revenues, operating earnings, and free cash flow. During this period, its revenues have increased by 270%, operating earnings (EBIT) by 888%, and free cash flow to the firm (FCFF) by 260%.
Currently, the biggest puzzle for this sector is if the ongoing market downturn will mark the end of the long-term growth period, in which case, the present rock bottom valuation could be justified. On the other hand, there is a high probability that this is just a temporal setback and that the market recovery experienced after 2015 will be repeated.
Looking forward, there are a lot of growth drivers in the semiconductor memory market. The four most important emerging ones are the rapid development of autonomous driving, strong growth of data centers, increasing memory capabilities of smartphones, and the upcoming launch of 5G communication networks. These technological market forces should help Micron to diversify across different end markets and to position itself into less connected and less intertwined economy segments.
In 2018, the total worth of the worldwide semiconductor memory market was $166 billion. With the growth of 27.2%, the memory sector was the largest and the highest performing semiconductor category. This growth should continue in the coming years as well, and it is anticipated that by 2024, the memory market will be worth $730 billion, which is compounded annual growth rate (CAGR) of 28%.
Micron is comprised of four different business units that target different end market segments. The traditional memory segment (CNBU) is the largest one and provides memory for data centers, graphics, networks, and enterprises. During the fiscal 2019 first quarter, this unit represented a whopping 46% of the revenues. The problem is that the periodic imbalances between supply and demand for the products from this unit previously led to the wild memory price swings and, consequently, to the roller coaster ride for the equity market.
The difference between the current situation and the last cycle peak (2015) is the strong technological development of less connected end markets, e.g. the automotive sector and Internet of Things (IoT). In the coming years, these technology trends will experience extensive development that could provide the counter-cyclical demand for Micron's traditional market. This should lower the volatility of revenues and earnings and smooth the movements of the stock market. Micron CEO Sanjay Mehrotra stated:
The impact of any supply and demand mismatch in the industry in the past would tend to be larger, but now such periods last shorter, mostly one or two quarters".
The DRAM market is the most important segment for Micron and, compared to 2015, it is more consolidated. In the future, this development could lead to less pricing war, as this market segment is essentially controlled by only three firms (Micron, Samsung (OTC:SSNLF), and SK Hynix (OTC:HXSCF)). Micron controls 24% of the DRAM market and, together, they control 96% of the total supply.
One more positive aspect compared to the previous market peak is a healthier financial position. At the end of 2015, Micron had $16 billion in revenues and $3.9 billion in net debt. At the end of the last quarter, trailing twelve months revenues were $31 billion and the cash position was plus $1.4 billion. During 2015, the leverage posed a threat, and nowadays, the cash provides an opportunity to repurchase Micron's equity at low prices or to potentially acquire a competitor.
Demanding safety and CO2 emission norms adopted by governments globally are playing an essential part in the progress of automotive technologies. From the percentage of the average vehicle costs, it is easy to see how fast technology is gaining a foot in today's automotive sector. During the past decade, additions as wireless communication, advanced dashboard displays, electric batteries, and autonomous driving systems have increased the cost share of automotive electronics in the average vehicle from about 19-21% to about 41-46%.
Micron is the number one supplier for this sector, and in the period from 2018 to 2024, it is estimated that the worldwide automotive memory market will grow at a CAGR of around 24%, at which point, it will be worth $11 billion.
The automotive sector is included in the Embedded business unit, which also contains the industrial, medical, and consumer market segments. During the last quarter, this segment was the smallest one with 12% of revenues. However, the long-term growth prospects will make it more important, as its solid upward trend can make the total company revenues and profits less volatile.
Source: Micron - Analyst & Investor Event
The 5G global enrollment should start in 2020, and the forecast is that the transition from 4G to 5G will force the data centers to increase its memory storage by four times, as the peak speed will increase 100 times to handle the 10 GB mobile connections.
For smartphones, the same 5G enrollment will require a similar growth of memory capabilities. Micron's internal projections are that during 2017, the average smartphone contained 2.7 GB of DRAM and 43 GB of NAND flash storage. Furthermore, their estimation is that by 2021, this will grow up to 4.8 GB of DRAM for average phones and up to 12 GB for flagship models. Similarly, the projection is that the average phone will need 142 GB of NAND flash memory and that some devices will need as high as one terabyte of flash storage.
These strong technology developments should serve as an opportunity to diversify away from the highly cyclical core PC market into the distinctive economy segments that have different growth/cyclical trends.
Source: Micron - Analyst & Investor Event
Despite being a part of a growth industry, with current valuation ratios, Micron Technology trades as a deep value investment. Currently, trailing twelve months enterprise value to earnings before interest, taxes, depreciation, and amortization (EV\EBITDA) is only 2.08. Similarly, enterprise value to earnings before interest and taxes (EV\EBIT) stands at 2.74, which is one of the lowest ratios for the whole US equity market. As the EV\EBIT ratio is below three, this means that with the current profitability, Micron would repay (ignoring the taxes) all its shareholder and debt capital within three years.
Furthermore, the current price to book ratio is 1.4 vs. the five-year average of 2.1, which points to the same undervalued direction. Micron's current enterprise (EV) value is approximately $42 billion, while its free cash flow to the firm (FCFF) is just below $9 billion. Thereby, its EV to FCFF stands at 4.66, which is quite low as well. For the last four quarters, free cash flow to equity is barely above zero, but this is due to the massive deleveraging and debt repayment.
Micron's strong cost competitiveness is reflected through the returns achieved on its assets, capital, and equity. From the fiscal year 2010 to 2018, Micron has posted the average return on assets (ROA) of 10.37%, the average return on equity (ROE) of 19.41%, and most importantly, the average return on invested capital (ROIC) of 14.47%. Relatively, high average ROIC shows that Micron is capable of maintaining a high level of return on its capital mix (equity and debt) in a different and highly volatile business environment.
Source: Micron - 2018 Analyst & Investor Event
Liquidity & Financial Health
During the last few years, Micron has conducted a massive deleveraging. According to the balance sheet from the last report, Micron has more cash and cash equivalents than the combined amount of short- and long-term debt (including capital leases). In other words, Micron has a net cash position.
On the last day of the first quarter for 2019, Micron had $4.134 billion of debt and $5.563 billion of cash, which results in $1.4 billion of net cash position. In the presentation for the first quarter, Micron used more broader cash definition which included the long-term investments as well. Under this definition, net cash is $3.1 billion. Such a strong balance sheet makes Micron financially strong, flexible, and ready for possible new acquisitions, but at the same time, it is less exposed to the potential future interest rate increases.
As the short-term debt is only $398 million and the free cash flow in the first quarter of 2019 was $2.3 billion, there should be plenty of flexibility for the stock buybacks as well.
Source: Micron Technology Inc.
Credit & Manipulation Scores
Altman Z-Score uses Micron's profitability, leverage, liquidity, solvency, and activity data to predict the likelihood of bankruptcy. This score currently stands at 5.90, which is higher than the threshold which stands at 3. This shows that there is no threat of bankruptcy and is just the confirmation for a healthy balance sheet described before.
Beneish M-Score, which shows potential for financial statements manipulation currently stands at -2.33. This is below the threshold of -2.22 and suggests that Micron is not an accounting manipulator.
The memory market is in a significant down cycle, but due to the rapid technological development of the different end markets, this situation should change. The long-term growth of the whole memory market should stay intact, and as the market is becoming more concentrated, this should go in favor of a less price competition.
In the long run, Micron has shown the above average efficiency and, currently, has a big pile of cash that provides flexibility for buybacks or potential takeovers. At the current valuation, market expects weak development of the memory market and prices Micron as one of the cheapest US equities. Such low valuation coupled with the growth prospects should provide a very good entry point with a high reward/risk ratio.
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.