Micron Technology: A Stock Which Can Go Up Significantly
Summary
- DRAM and NAND industries are growing quite fast.
- Micron Technology stock is significantly undervalued.
- Based on 2022 EPS estimates, the stock could rise to the $200 level.
Micron Technology, Inc. (NASDAQ:MU) benefits from industry trends. Analysts expect tremendous growth for the company. At the same time the company is used to beating analysts' estimates at large surprise rates. Valuation models indicate considerable undervaluation.
Micron Technology is operating in a rapidly growing semiconductor industry. The company sells DRAM and NAND products, which represent 30% of the semiconductor industry. DRAM sales represent 71% of company's sales while 26% of company sales come from the NAND segment. The DRAM market is estimated to be $66.8 billion and is expected to cross $100 billion mark in 2026. Micron sells approximately $17 billion DRAM products representing 25% market share in the industry.
The industry promises great growth opportunities as the application of the technology expands beyond traditional personal computers and mobile devices. It is being used in the automotive industry, cloud-based businesses and in servers. According to Micron Technology, the AI based servers need 6 times more DRAM than traditional servers do.
Automotive industry trends bring tremendous tailwinds for the DRAM industry. ADAS - Advanced Driver Assistance Systems - and autonomous vehicles demand strong processors that require huge memory capacity, which is only possible with DRAM technology. In the automotive segment, Micron recorded the second consecutive quarterly record by sales numbers. The management estimates that the demand in the sector is higher than supply, which will obviously bring inflationary pressure in the market. The company is developing its operations in the segment as in Q2 the company completed qualification of auto-grade LP5 and started testing automotive LP5, which is tested to meet the highest Automotive Safety Integrity Level, ASIL D.
The pandemic has quite beneficial effects for the company as it increases the speed of digitalization. Work-from-home culture increases demand for laptops considerably, as people start to work and learn remotely. Thus the management expects that the sales of PC units will approach 1 million units per day in 2021. Desktop PC sales are also expected to recover as the pandemic is continuously retreating and the labor force is returning to their workplaces.
Mobile Sector is expanding quite fast as the 5G technology which is widely used in new phones requires DRAM. The management expects that 5G phone demand will double in 2021 and will become 500 million units.
The management announced that they expect more than 30% DRAM demand increase in 2021, as they anticipate supply shortages in the industry. Due to the demand surge global prices of DRAM are increasing sharply. Current prices are up 60% YTD, and are at all-time highs exceeding March 2019 record.
The management has very optimistic expectations. They expect Q3 Revenue to increase to $7.1 billion - 30% YoY increase, at the same time they expect gross margin to be approximately 41.5%. The estimated gross margin is considerably higher than Q2 gross margin of 31%. Analysts are also quite optimistic as they expect 25.5% revenue increase, and 93% EPS growth rate for FY 2021. From the first sight the numbers seem overestimated; however, the company was able to consistently beat analysts' expectations in recent years.
In the recent 16 quarters, the company beat revenue estimates 15 times and earnings estimates 16 times. The quarterly average revenue surprise rate was 2.63%, while EPS surprise rate was 12.2%. So we should anticipate positive surprises on earnings dates.
At the same time, analysts revise their estimates upward frequently. Revenue estimates for FY 2021 have already been revised up by 16% during the last 6-month period, while EPS estimates for FY 2021 have been revised up by 79% during the same period.
Source: Author's Spreadsheet
Valuation
For the next 5-year period, analysts expect a 10% revenue CAGR. Given the current positive market environment, we can assume this expectation quite conservative and adopt it for our DCF Model. As a perpetual growth rate we adopt 2% rate. 1.24 beta coefficient, 4.76% equity risk premium and 1.7% risk-free rate result in 7.6% discount rate. The DCF model indicates $133 intrinsic value which is 40% higher than current market price.
Source: Author's Spreadsheet
Taking into account the fact that interest rates are rising, we can adopt 8.1% discount rate and 9% CAGR for the next 10-year period. The 9% growth rate coincides with last 10-year periods' revenue growth rate, so it can be more conservative. Considering these inputs our model yields $103 stock price which is 10% higher from current price level.
Micron Technology trades at a considerable discount compared to its peers. Considering P/E (FWD) ratios and expected EPS growth rates we come up to PEG (FWD) ratio. Peers' median PEG ratio is 2 times higher than Micron's ratio, which means that the intrinsic value stands at $213.7 - 120% higher than current stock price.
Source: Author's Spreadsheet
Analysts estimate $5.48 EPS for FY 2021 and $10.83 for FY 2022. Given the booming industry trends and Micron's huge R&D power we can conclude that the stock needs to trade at multiples above market average multiples, so even if we consider P/E ratio of 20, the stock price should trade at $216 level in 2022. However, the current price is far from this level, indicating that there is a considerable undervaluation.
Threats
The company is operating in an industry where competition is rather viscous. There were tremendous amount of memory chipmakers 15 years ago, however only few of them were able to survive. The technology is developing quite fast, that is why those companies which can't innovate rapidly are being pushed away from the market. Micron Technology was able to overcome this threat in the last decades, as it has a powerful R&D division and spends heavily on CapEx.
The company is also exposed to foreign exchange risks, as a part of its revenues and production comes from abroad. In 2020, currency market was rather volatile as the coronavirus threat urged governments to "print" lots of money causing lots of uncertainties in currency markets. We expect these uncertainties continue to exist in upcoming quarters and even years.
Portfolio
The stock proposes a well diversification opportunity as it has quite low correlation with S&P 500 (SPY). Correlation Coefficient stands at 47.7% while R-squared is equal to 22.83%.
Source: Author's Spreadsheet
We have also made a backtest and compared 2 portfolios: Portfolio 1 (50% MU and 50% SPY) and Portfolio 2 (100% SPY). As a result, our Portfolio 1 has 21.5% CAGR for 10-year period while Portfolio 2 has only 13.81% CAGR.
Conclusion
DRAM and NAND industries are expanding quite fast. The industry trend gives huge tailwinds for Micron, promising fast growth opportunity in upcoming years. Our valuation models indicate that the stock is considerably undervalued, thus we assign Strong Buy rating to the stock with a price target of $133.
This article was written by
Analyst’s 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.
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