June 2016 was a phenomenal inflection point for Micron (MU). The stock rose over 600% in the ensuing 24 months. The burning question now is whether 2019 is going to present the same opportunity. Depending on who is asked, the answer could vary widely (and wildly). Here, we present 5 factors that cast reasonable doubt on 2019 being the new 2016. In fairness to both sides we will also present rebuttals to these 5 points as best as we can.
To be sure, Micron is in a far better place in 2019 than it was 2016. Micron is net cash positive, has about 300% higher book value, and earns far more now. Micron is also much more competitive against the Korean competition. This article is not a direct comparison of how Micron is doing between these two periods. Instead, it is an examination of whether the two periods represent similar trough bottoms. A trough bottom happens when a sustained shift in sentiment occurs towards near future being better than the recent past. It stands to reason that this shift doesn't occur in a vacuum. Let's jump right into examining some of the reasons why June 2016 was a turning point and whether those same catalysts apply now.
1. Quarterly Earnings
During previous trough, quarterly EPS bottomed when Q3 2016 ER was released. This coincided closely with the start of the long rally starting May 17, 2017. Fast forward to June 2019 and it is doubtful that the latest ER represented a bottom in quarterly earnings. Management has guided a near 50% decline for the next quarter.
If the bottom share price has already been set for the current trough, the December 2018 low would represent a minimum of 3 quarters between the share price bottom and the quarterly earnings bottom. This obviously is not the same pattern that led to the rally in 2016.
2. DRAM Spot Prices
We did not keep track of the spot prices back in 2016 so for this comparison we have to refer to previously published materials by some SA Greats.
This chart shows that the spot prices for 8GB DDR4 also bottomed around May of 2016.
The above 3 charts indicate that the trough bottom in 2016 coincided closely with the bottom for spot prices for the most popular DRAM modules.
In contrast, spot prices now are showing no signs of stabilization. As the chart below shows, they have continued the declines that began in 2018 throughout the first half of 2019.
Notice that in just the first 6 months of 2019 the spot price for DDR4 8G module has more than halved.
3 - Cycle Periods
For Micron, the average memory cycle has lasted slightly over 4 years in the past. The following chart shows a reasonable delineation of Micron's previous 4 cycles.
During this period, the trailing portion of every Micron cycle (downcycle) has lasted between 6 and 10 quarters. We are currently in the 4th quarter since the latest peak in 2018. If June proves to be the bottom of the current trough, it would make this downcycle 4 quarters in total length, the shortest since 1998.
It is therefore possible that the downcycle has not had time to run its full course yet.
Unemployment is currently at 3.7%, the lowest level in 50 years. The odds are that it will form a bottom sometime soon. As the chart below shows the two previous unemployment bottoms since 1998 presented headwinds for Micron's stock.
The effect of unemployment bottom on Nasdaq is even more pronounced. As can be seen in the following graph, 4 out of the 5 unemployment bottoms were not kind to Nasdaq.
Please note that Nasdaq prices are plotted using log scale to make the prices before year 2000 discernible.
5. NAND Transition
One tailwind Micron enjoyed in 2016 was its NAND architecture. Back then, Micron was in the early stages of reaping the benefits of the so-called CMOS under the Array or CUA architecture. CUA provided cost benefits compared to the competition. Here is an excerpt from a Micron blog published on December 9, 2015:
Micron had the foresight to put as much of our CMOS (logic) underneath the memory as we could, which makes the total chip size not much bigger than what is absolutely required for the memory array. We call this innovation, CMOS Under the Array, or CUA for short. Our competition does not do this, and the result is less gigabytes of storage within a given chip area.
Sticking with that military theme, we in the flash industry are always in battle to lower costs faster than our competition, and Micron just launched a salvo with CUA that is going to be hard for anyone to recover from.
On the other hand, Micron is currently facing potential headwinds related to its NAND production. It will have to play catch-up next year when it transitions manufacturing processes. Micron is going to switch to replacement gate in 2020. Micron is also likely going to switch from floating gate to charge trap technology. These are technologies that the competition has already been using for years. It is reported here that Micron will keep the CUA architecture after the transition but any benefits would initially be muted as competition has far more experience with replacement gate and charge trap technologies. Here, you can read about why some believe that Micron and Intel were wrong initially for going with floating gate technology.
Micron's NAND production technology gave it an advantage in 2016 whereas now the upcoming transition will put it at a disadvantage.
There are many arguments that can constitute valid rebuttals to these points. We'll present a few below.
Let's begin with quarterly EPS. The risks to the assumption that quarterly EPS and trough bottoms are tied are many. First, Micron was mired in over $10B debt including some toxic notes that negatively impacted share price in 2016. The debt issue has been practically resolved. Micron is also much more competitive now. These two factors greatly enhance Micron's ability to survive any unexpected and severe downturn. Long term investors are more likely to initiate positions early when risks of bankruptcy are mitigated.
Next let's look at the DRAM spot price declines. For this rebuttal we will defer to another SA Great, Mr. Joe Albano who provided the following insightful nugget in a comment exchange.
I am truly impressed with management's execution. However, the problem I have is that there is no sign of slowdown in DRAM price declines. We know that NAND is not going to be a cash cow for them anytime soon with the upcoming transition. Predicting demand pickup and inventory reduction is all good and well but they sure didn't predict the environment correctly last year. They weren't even close. This run reminds me of the rallies last year when it soared multiple times on heavy volume only to drop back down as rapidly as it had risen. I believe Cramer blamed it on hot money.
FQ2 DRAM ASPs declined about 22-23% according to Micron and then in FQ3 DRAM ASPs declined about 19% and Trendforce expects 12.5% decline in the CQ3 (roughly MU's FQ4) and 10% decline in CQ4. Now keep in mind Trendforce has always been on the heavy side. When Micron said they had declines of 22-23% Trendforce was saying it was -30%, and when Micron said about -19% Trendforce was saying -25%.
Now with Trendforce saying 12.5%, it could very well be -10% for Micron. As far as I know that's *at least* a sign of a slowdown in DRAM price declines.
I'm always baffled by the articles and authors who say "we will wait until we don't see any more DRAM declines..."
Uhmmm? That's not how the industry typically works. Micron has said they can absorb a 15-20% yearly decline. That means quarterly ASPs can decline by 5-6% and the company can be growing. I don't know about you but Micron nearing -8% DRAM ASP declines in Q4 (FQ1 2020) sounds like a massive turnaround to me compared to -23% in Q1.
As far as cycle periods are concerned it is worth noting that the previous 3 downcycles lasted 10, 8 and 6 quarters respectively. So, it is certainly not a stretch to imagine that this one would keep with this trend and be two quarters shorter than the previous.
Regarding unemployment rate, the argument can be made that just like the 1951-1953 period when unemployment bottomed at 2.5%, unemployment rate now could simply continue to drop (or stay flat) for the next few years.
Lastly, the claim can be made that NAND transition is unlikely to create a serious headwind. Micron continues to supply NAND in an ever-increasing mixture of value-added products with higher margins and less cyclicality. This should neutralize any headwind the upcoming transition may create.
Obviously, each side has some compelling arguments which explains why investors and analysts are so divided. Adding to uncertainties are binary events such as trade impasse resolution or lack thereof or possible interest rate cuts. We believe the effects of such binary events though potentially dramatic at first would be temporary and not a factor in the upcycle timing.
Everything considered, our bottom-line view of the current environment is that caution continues to be warranted.
We have been criticized for our sidelines strategy and many bulls have questioned our motivation for comments that did not fit their view (or desires). The truth is that we are just as eager as any other bull for the upcycle to start and bring about the long-awaited sustained rally.
Our response to waiting it out and missing out on part of the rally is our limitless capacity to miss. Our miss account balance is so large that it makes US GDP look puny. We can miss the equivalent of Microsoft (MSFT) market cap and not notice the smallest hit to our net worth. Our loss capacity on the other hand is quite limited. Thus, we have concluded that given the uncertainties, it is more prudent to protect against losses instead of worrying about misses. As such, we continue to believe that sidelines is the best place to be at the moment.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
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