Micron: The New Paradigm Unfolds
Summary
- As many companies disown or halve earnings projections due to COVID, Micron shows its pedigree by raising guidance and reiterating an improving future.
- One factor is company-specific: the remarkable diversification in Micron’s supply chains that enabled production to be reconfigured in the face of country lockdowns and specific bottlenecks.
- The second factor is a new secular tailwind: a rise in Home/Office computing that’s led to a surge in digital memory for the offsite employee. Plus, 5G mega-memory smartphones!
- A perennial investor fear has been inventory obsolescence. The article substantiates why changing industry dynamics necessitate larger inventories and why this is no longer a precursor to a bust.
- An invaluable insight was articulated by the CEO only last week, on why the ’18/’19 volatility in DRAM ASPs is highly unlikely, via a new maturity in data center mindsets.
Micron (NASDAQ:MU) has just shown its excellence: where most companies are busy disowning forecasts or halving them, Micron actually raises for the next quarter and states visibility through COVID is improving. The revision was articulated at the Bernstein Conference by CEO Sanjay Mehrotra only last week. Valuable insights were divulged and are detailed here, but I urge readers to listen to the presentation also.
Before I address insights revealed at the conference, it will be helpful to outline the evolution of the digital memory industry.
The Emergence of an Oligopoly
This section summarises two decades of a dynamic landscape. I have covered the history in more detail in a previous article; please refer to Micron: Fear Of Inventory Impairment Fueled By Trade Spat Is An Opportunity for a deeper analysis.
Two decades (1997-2017) depict an industry rife with innovation and a vicious struggle for survival by numerous suppliers, each vying to secure a place in the future. No doubt, the stellar growth in demand of both NAND and DRAM portended rich harvests for survivors of the digital gunfight. However, the cost to play was a big R&D budget to remain "technologically current" in an industry evolving at a frenetic pace.
Quantum leaps in all aspects of memory design and manufacturing permitted massive cost improvements every year… the rate of technological progress was so rapid that if a supplier couldn't get its inventory out the door in a given quarter, it was virtually worthless in the next, because some other supplier that had kept pace with the digital beat offered a superior product at a lower price. As a result, the pace of innovation rendered inventory obsolete in a matter of weeks if it wasn't sold, leading to a dramatic culling and 'survival of the fittest.'
Natural selection was vicious; few survived. For NAND, since 2001, a dozen suppliers that represented one-third of the market have vanished, leaving just five players that represent 94% of supply (about $40 Bn pa of NAND memory). The consolidation in DRAM has been even more extreme, where three players have emerged to supply 97% of the global DRAM ($60bn pa), displacing a Motley crew who represented about 25% of the market in 2008.
But another law began to emerge in the digital jungle: the law of diminishing productivity. In the early stages of a product lifecycle, the cost improvements were massive, but later, constraints in manufacturing, design, and even the natural laws of material physics led to smaller and less frequent improvements.
The three global DRAM suppliers estimate the current rate of improvement in cost/gigabyte is 5% pa, whereas 40% quantum leaps (both in cost and storage density) were the norm a decade ago. Furthermore, the capital investment necessary for that marginal improvement has soared, as the complexity of squeezing yet another kilobyte of data into a nanometre of wafer that's already three-stories high has deepened.
Well, that tale brings us to today, arguably, the Golden Era of Memory, where a handful of players in both DRAM and NAND are finally in a position to capitalise on the enormous legacy investment, both in intellectual property (patents, know-how) and cutting-edge manufacturing capacity.
A critical issue is the longer life of inventory as we enter the age of a slower rate of marginal improvement. An important issue, still only partially acknowledged by investors, is that the corollary of a slower rate of cost improvements is a longer inventory shelf-life.
The best way to convey this paradigm shift in the industry is via a long-term graph of inventory and profit margins. The data for Micron's graph below can be found in my instablog here.
Note that, in the past, anytime inventory approached around 80 days, Micron would incur a dramatic fall in operating margins, often even going to a loss, as it dumped the worthless obsolete inventory. The inventory dump would be either in that quarter, or one promptly after when the accounting recognized the impairment.
This fear was still prevalent in the last three years, as investors assumed that inventory approaching 100 days would lead to a massive impairment and losses, as it had always done in the past.
Yet this has NOT repeated itself in '18/'19 where the graph above illustrates that margins and earnings remained positive despite inventory days rising as high as 150! Mr Market still has to fully acknowledge the new paradigm in Micron's Valuation Rating (PE).
Home/Office Shift
In the conference, CEO Mehrotra attributed the lift in guidance due to the current demand from Home/Office Computing. The lockdowns have made companies realise a swathe of employees are perfectly capable of working offsite efficiently, permitting a cost reduction in office space. This shift is unlikely to reverse itself after businesses revert to normal after COVID.
So, the COVID environment as we mentioned, has actually resulted in acceleration of the digital economy. And that has seen a surge in workloads related to work from home economy, on the data center side
5G and Mega-memory Phones
A secular driver in memory is 5G networks and the increased need for memory at the consumer interface in applications that involve AI and real-time data processing (e.g. navigation & image-recognition apps).
The CEO summarized at the Conference last week:
5G is going to be a long multiyear growth cycle for smartphones. It will reignite the smartphone unit sales. And 5G also drives increased content for memory and storage So, when we look at longer term trends, 5G will be a significant growth driver for multiple years in terms of increased unit sales, as well as increased content for both DRAM and NAND.
Micron 5G implications for Smartphones
Source: Mobile Business Unit Update: Winning in the 5G Era
Data Centers: The volatility of '18/'19 and the new maturity
Although there was greater discipline in suppliers over '18/'19, demand remained volatile. A key cause was data centers which witnessed a surge from enterprises shifting to the cloud. As demand for data servers roared, many cloud providers - alarmed at the rise in DRAM ASPs - began to pre-order. In 2018, DRAM demand was estimated to rise a frenetic 44% over the previous year, as the pre-ordering exacerbated the tight market. The boom was followed by a fallow period in 2019, as shown in the price volatility of a data server DRAM package below:
Source: Camel DRAM Package
The detail of the DRAM volatility induced by data centers is covered in greater detail in my article Micron Q4 F'19 Earnings: All In Order, Despite Friday's Ghastly Market Reaction - Buy
Cloud Center: Feast to Famine Again?
Those scars still linger in the memory (pun intended) of investors who remain fearful of another bust in the near future. The investor fear and Micron's response is summarized at the recent Bernstein Conference.
Analyst Question:
What about the volatility caused by data centers? The hyperscalers or the cloud service providers, these companies tend to be very lumpy in their purchases. They tend to have five quarters of huge strengths and five quarters of weakness. We saw 2019 was very, very weak and so far this year extremely strong…. the critical kind of thing that investors are trying to figure out how many more quarters have we got of this data center strength?
CEO Response (my bold italics)
The COVID environment, it certainly does bring lower visibility and does bring some element of uncertainty in all industries. I would like to say that the kind of volatility that was experienced in 2018-2019 kind of timeframe....those cloud customers also would not want to have that kind of volatility, because it is better for them, as well as for us.
Cloud customers definitely have matured in terms of their buying patterns and understanding of the industry as well. And from our dialogue, we were closing with these customers, we are a major supplier to these customers, we worked closely to understand what their demand and product requirements are. And Micron is - they are valued partners to us, the cloud customers, and we are valued partners to them as well.
There is no doubt this is still a possibility, but one must remember even through COVID, data center demand has remained robust. Despite an overall contraction in IT spending in 2020, cloud services is expected to actually post growth, as per Gartner.
Gartner is predicting a 19 percent surge in public cloud services revenues in 2020 as the coronavirus pandemic spurs remote working. Cloud-based telephone and messaging and cloud-based conferencing will see high levels of spending growing 9 percent and 24 percent, respectively.
Valuation Summary
As an avid investor in Micron, I will be the first to admit the cyclicality is NOT for the faint-hearted. However, in light of the shift to an oligopoly of disciplined suppliers and a more diversified customer base, plus a matured relationship with data centers that will permit a more co-operative, coordinated relationship to mutual profit, all these combine to depict a far less volatile future.
The graph below shows, contrary to previous troughs (sharp decline in ASPs as in 2019), Micron did not move into losses in any trailing 12-month period, but remained profitable (lowest TTM EPS was $2.0 in 12-month to Feb '20, compared to -$0.30 in the previous trough in 12-month to Nov '16).
Once investors fully digest this paradigm shift, Micron's valuation rating (best summarized by the EV/EBIDTA ratio, as per the graph below) is bound to rise. It's still far too early to estimate the next peak in earnings, but I expect the last 12-month EPS peak of $12.1 (Nov '18) to be eclipsed.
I also expect a plateau of EBITDA around $10 per share in a number of years, starting from the fiscal year to May '21. In other words, the feast/famine of the past will be replaced by a sustainable multi-year period of healthy earnings. This is bound to raise Micron's valuation rating. As a first yardstick for valuation purposes, let's stick to EV/EBIDTA ratio of 10X. Using my EBITDA of $10 for F'21, an easy target of $100 is generated. In a word: Buy.
This article was written by
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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (400)
www.aspeedtech.com/...
'Micron did not loose money in the last down cycle. 'if you were more diligent (with your imitation - see below),
you would have seen it's 'lose' not 'loose' anyway hope that helps, not hurts@mksd
I was looking up 'maximum pain' wrt Micron options, you had some comments. FWIW my intuition's saying it's currently the tail wagging the dog... Any comments you have for Micron's bizarre price action in the last few days, from options and max pain? thanks in advance
The age old micron paradox: "if its good now, it will be bad later" Prices went up significantly. its too good so we should sell now" Spot prices dropped significantly between mar and june . Contract and Micron prices follow spot on a delay (where is phred with the graph?). Prices will drop 5%+ in Q3 (seems unlikely since Micron knows pricing and gave guidance)Inventory rose again... it should not be rising now. All of the trade possibilities are bad. either micron cant sell to someone or US wont buy from someone micron sells to. Micron is based in Idaho. Congress is voting to declare Idaho an Alt-right Fascist organization and outlaw all companies located there. Google and Facebook will delete all links to the company[I made up the last part... that won't happen til Jan 3rd 2021, so we got a few months]
I'm adding a sketch of our 3 Giants Markson, Samson and HiJinx playing poker in a cosy cartel.
BUT I DONT HAVE A CLUE ABOUT THE GAME...POKERSo does this parody sketch sound vaguely authentic:
Any Big Blunders? Please tell me.From article in SA Pending Box (for 4 hours, untouched!)Digression: The Digital Giants’ Poker GameIt’s approaching midnight. The wannabes have all been cleaned out. Pockets empty, smiles even emptier, the only ones left behind are the three seasoned veteran wolves.Markson ($MU) stands up and deals. He yawns loudly, looking at his wristwatch for greater effect. For two rounds, chips leave their owners’ stacks and gather in the middle.Markson's turn. He swirls his chip expertly between his fingers but then puts it down instead. He looks directly at the other two.“If you raise, I match you Samson ($SNLF) or you HiJinx... so why raise at all! When we all have our cigars, a tidy gain... basically we cleaned them upstarts with their probability crap right out!““Whaddamoredawewant?” Samson agrees. “Let's get some Rib-eye while we're all ahead. Right?”“Hell yay” says HiJinx ($HYNX), gathering his loot.They all start packing up.
you dont need to go to Vegas.
Does the action resemble a poker game...?
or are you as clueness as I here....
:)
'@Sunil Shah I've been following you since 2018. You're just like me in that you see the value of MU - your logic is sound and you have a firm grasp of MU's financials and you have reasonable projections for future revenue and earnings. However, maybe its time we both realized the market just doesn't see things the way we do.'
THEY HAVE TO SEE THINGS THE WAY I DO, OR THEY ARE NOT PERFECT
Arrrrgh!!!!
in this crazy world, one never knows
Raymond James: Strong Buy, $60 --> $65
Morgan Stanley: Overweight, $63 (unchanged PT)
BMO: Market Perform, $49 --> $55
BofA: Buy, $70
Citi: Sell, $35 (1.1x book value)
Can't help but chuckle at Citi's report. Absolutely shameless. Christopher Danely has been absolutely dead wrong on the company's fundamental performance AND stock price moves for about two years in a row running now.
i really hate these words:
"BUT I TOLD YOU SO!!"Hope you and @Retired One and @kimbillro are on the right side of this.
I couldnt help start scribbling another article, given how well I've read this baby.
summary:
"Micron: The Paradigm Unfolds Further: $100 A Visible Target "As many companies disown earnings projections ravaged by Covid, Micron shows its pedigree by raising guidance and reiterating an improving future.Four weeks after material insights provided at a conference the CEO augments a promising future in the 3Q F20 (May) conference call.
This article is a short but essential extension of a detailed buy recommendation published last month, focusing on two significant points.
After a 3-year phase of material Capex investment in new capacity, Micron eases into lower phase of lower capital budgets. The operating cashflow thus liberated is spellbinding; Mr Market hasn’t yet digested Micron’s capacity to increase sharebuybacks. and
One investor specific investor concern is Micron’s exposure to the political 5G football called Huawei. Micron has skillfully pivoted away from Huawei without losing sales momentum. The above insights, one on the cash spigot, and the other a diversification of political risk, secure a $100 target. The only question is how long Mr Market takes to digest the data: 12 weeks or 12 months. But digest it will. Buy! "
i disagree due to the phenomenal jump in earnings and confidence
i hope over 60 by end of week
lets see....
'How many times have we seen the same jump AH on earnings, followed by a complete collapse the next day?'THIS TIME It'S DIFFERENT
You have my guarantee
:)
'FCF was near zero this Q right?' Right. 2bn op cash flow= Capex.for the qtr.
But fiscal annual Capex forecast to be - 40% yoy for f20.
So about $5-6bn.
And op cash flow about $10bn in f20 and Imo +14bn $ in f21 if ASP s continue to rise. That spits out $9-10bn of post Capex cash flow in f21.
OR MU marketcap/free cashflow of 5X for f21 currently!!This leads to my target price = $100/share as visibility of F21 crystallises.NB: Management are always cautious to be bound by a Capex figure, thence permitting leeway if misconduct by other oligoplolists. Markson Continues,
'If you raise I match you Samson or hiJinx, so why raise when we all have cigars a good final hand and a healthy night of poker winnings! Whadayyawant?Let's get some Rib-eye while we're all ahead. Right? Hell yay' They all start packing up. But the cash spewing nature of MU biz combined with drastic reduction in f21 capex is spellbinding, IMO
.
I would be v surprised if $60 / share is not breached by the end of week.
BY FAR THE CHEAPEST DIGITAL MEMORY COMPANY in S&P, yet offering a powerful revenue-accretive gamme of productGo Micron!
ELABORATING ON ABOVE CAPEX DYNAMIC:Pre-covid MU expected to invest more in f21 BACK TO $8BN NORM
However post covid f21 capex is CURRENTLY forecast to be down meaningfully, giving the extra fire-power for share repurchases.from Bernstein CC, in May 2020
seekingalpha.com/..."And, in fact, in fiscal year '20, our CapEx is down by more than 40% for equipment spends. So, our CapEx strategy is to focus on supply growth CAGR to be in line with demand CAGR expectations. And we remain extremely focused on making sure that we're managing our CapEx, we're managing our supply growth carefully to make sure that our supply and demand are in balance and we're extremely focused on ROI as well.So, pre-COVID, we were expecting that our fiscal year '21 CapEx would be higher than fiscal year '20. Again note that fiscal year '20 was meaningfully lower than fiscal year '19. But, as we encountered the COVID situation, we have made adjustments to our plans. And our CapEx expectations at this point are lower -- for fiscal year '21 are lower than our CapEx expectations pre-COVID. So, you can see that we are continuing to review this, continuing to make adjustment. We'll continue to monitor this over the course of next few months as well. And, of course, as we get closer to talking about fiscal year '21, we’ll provide you further specifics related to CapEx."
OP CASHFLOW IS GOING TO ROAR!!
$2BN THIS QTR AND RISING!!!!
shares will be repurchased like water....
look out for next approval for further share purchases
I dont think Capex impact OP Cash flow. ... and FCF was near zero this Q right?
Correct. Share count started rising as soon as they halted the share buybacks.
The following table presents Micron’s guidance for the fourth quarter of fiscal 2020:
FQ4-20 GAAP(1) Outlook Non-GAAP(2) Outlook
Revenue $5.75 billion - $6.25 billion $5.75 billion - $6.25 billion
Gross margin 34.5% ± 1.5% 35.5% ± 1.5%
Operating expenses $900 million ± $25 million $850 million ± $25 million
Interest (income) expense, net $33 million $30 million
Diluted earnings per share $0.88 ± $0.10 $1.05 ± $0.10
Further information regarding Micron’s business outlook is included in the prepared remarks and slides, which have been posted atso current street consensus for next qtr is 81 cents
THAT IS A SOUND BEAT AND RAISE WITH COVID
WHERE EVERY COMPANY IS DISOWNING FORECASTSyay!
so current street consensus for next qtr is 81 cents!!!
but lets give it a year
yay!
couldnt be bettr!
beat on rev and margin
NOW TO RAISE OUTLOOK!
YAY!!Revenue of $5.44 billion versus $4.80 billion for the prior quarter and $4.79 billion for the same period last year
GAAP net income of $803 million, or $0.71 per diluted share
Non-GAAP net income of $941 million, or $0.82 per diluted share
Operating cash flow of $2.02 billion versus $2.00 billion for the prior quarter and $2.71 billion for the same period last year
-value added NAND embodying higher margin expected to be 80% of NAND mix. THIS DYNAMIC HAS PREVAILED FOR ABOUT 4 YEARS AS MICRON MOVES UP THE VALUE - ADDED PYRAMID IN NAND) So despite covid uncertainty and current slack in ASP spot markets, Micron has the conviction to raise margin forecast for August Quarter, attributable to value-added NAND.... Whoa!!
Rosenblatt: reiterate Buy, $100 PT
BofA:
Micron had already raised guidance for May-end 3Q FY20 results on 28 May (GAAP EPS revision +55%, even with +8% sales and +2.5ppt gross margin vs management's view as of 25 Mar). Consensus estimates have also increased QTD. Thus, we acknowledge our positive view on Micron appears in line with both consensus and guidance. That said, management will likely confirm sales/profit improvement for Aug-end quarter (4Q FY20) at 3Q results call (29 June), given (1) stable ASP (or decent increase), (2) volume growth, and (3) cost reduction. Capex cut for FY20 (by 20-30%) is also likely to be reiterated; positive for peers (Samsung/Hynix), but negative for equipment vendors.Rosenblatt:
Better-than-expected pricing and supply/demand trends along with data center demand as well as the WFH environment’s impact on notebooks and gaming are all highlighted as reasons to be positive. On the other hand, expect these to be offset by “weak trends in smartphones, consumer electronics, and automobiles.”Looking ahead to the August quarter, Mosesmann expects sales to exhibit a mid-single-digit quarter-over-quarter increase. Improving DRAM and NAND trends - and once more - data center, 5G, notebooks, and game consoles, are all set to drive higher sales. Mosesmann also anticipates smartphone demand to stage a recovery.“In addition, our sense is that ASP's for DRAM/NAND are on the upswing as stronger segments drive bit demand and near-term weaker segments prepare for a recovery in 2H20,” Mosesmann concluded buoyantly.
https://dramexchange.com/
We expect pricing for DRAM and NAND to be flat to slightly up QoQ in C3Q following
significant increases in C2Q. Except in mobile, inventories are lean. Lingering supply
chain disruptions, 2H seasonality, along with easy comps for C2021, lead us to
believe the memory supply chain will be holding inventories, rather than cutting in 2H,
suggesting price stability. For Micron, we are modeling flattish EPS for F4Q followed
by a significant recovery throughout F2021. Neutral-rated■ Our recent Asia supply chain checks point to an expected stabilization in
both DRAM and NAND pricing into C2Q20, leading us to model flattish gross
margin for Micron for the next couple of quarters, followed by a gross margin
recovery in 2HF2021.
- While the memory consumer market has weakened since April, there are early
signs of consumer improvement.
- Bit growth is expected to be flattish in 2H sequentially following 15% bit growth in servers in 2Q, driven by some inventory builds and as memory capacity shifted from mobile to servers.
■ DRAM pricing C3Q outlook is flat to slightly up QoQ after double-digit increases
in both servers and PCs in C2Q.
- DRAM inventories are high in mobile, low in servers, while PC OEMs continue
to build inventories from current 1.5 months level.
■ NAND pricing C3Q outlook is also flat to slightly up QoQ after a high singledigit increase in C2Q.
- NAND inventories are lean both on the supply and demand sides.
■ Inventory and price stabilization in 2H. Lingering supply chain disruptions,
potential seasonal recovery in 2H, along with easy end-demand comps for C2021,
lead us to believe the memory supply chain will be holding inventories, rather than cutting, in 2H, suggesting price stability.
■ We continue to model $4 in PF EPS (inc. stock comp) for Micron in F2021.
Post an EPS trough in F2Q (ended Feb), we are modeling flattish EPS QoQ for
F4Q (ended Aug), followed by a significant rebound throughout F2021.
- We model annualized EPS of about $5.50 exiting F2021.
the DRAM market. We believe the large hyperscale companies have likely adjusted their buying patterns for the 1H/2H from an earlier estimate more in the range of 55/45 to now likely 65/35, with a larger amount of procurement ending up in the 1H. We are also hearing of meaningful downward order revisions from at least one of the larger hyperscale companies, well in the high-double-digit range for 2H vs. 1H. Lowering estimates. We are lowering our ASP assumptions for both DRAM and for
NAND and are consequently lowering our estimates. Our FY20 and FY21 estimates go to $2.47 and $4.40 vs. prior $2.22 and $5.25. We are also lowering our target price to $55 vs. $60.
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