Micron Technology: Margins Have Not Peaked Yet
Summary
- Micron will now start to pay a cash dividend.
- The dividend is, however, not a good reason to buy the stock. Micron is a buy based on its expected revenue growth and gross margin expansion.
- Micron is rolling out new 176-layer NAND products which should help accelerate top line growth next year.
- Micron is still undervalued based on its growth potential.
Micron Technology (NASDAQ:MU) signaled a shift in its dividend policy when it announced the introduction of a cash dividend this week. As a growth company, however, Micron's revenue acceleration, gross margin growth and multiple expansion are better reasons to buy the stock.
Why Micron is a long-term buy
One of the key reasons to buy Micron relates to continual margin expansion and revenue growth. Micron's revenue potential, short term, is tied to the undersupplied DRAM market which creates favorable profit growth and pricing tailwinds in the coming quarters. The DRAM shortage has been responsible for strengthening average selling prices/ASPs in the segment which are also key to Micron's strong guidance for FQ4'21. DRAM ASPs increased only slightly in FQ2'21 but growth really kicked into high gear in FQ3'21 when average selling prices for DRAM surged 20% Q/Q. The rise in DRAM ASPs is directly related to demand strength in end markets with the semiconductor shortage favoring pricing as well. For FQ4'21, I expect this momentum in DRAM pricing to continue which should lead to strong sequential revenue growth and strengthening gross margins. Micron's guidance for FQ4'21 implies at a minimum 8% sequential revenue growth, and up to 13% Q/Q revenue growth in the "high case". Micron grew its top line 19% Q/Q in FQ3'21 and actual revenues were more than $100M above the top range of guidance. As for gross margins, Micron expects to expand on recent margin gains - in part due to accelerating strength in DRAM pricing - and the gross margin is expected to be at least 46% in FQ4'21.
(Source: Micron)
I don't believe Micron's gross margins will peak in FQ4'21 and the memory chip maker has more potential to grow its profitability in FY 2022. The main factors enabling this projection are that DRAM ASPs growth accelerated in FQ3'21 and that the supply shortage will likely last into next year… which gives Micron a few more quarters of strong bit shipments and rising product prices at the same time. This combination of factors is all but guaranteed to have a positive effect on Micron's margin development and it creates a setup in which the memory chip maker could hit or exceed a 50% gross margin. The trend in Micron's revenue and gross margin growth is accelerating, which makes a strong case for a higher earnings multiplier factor for Micron's stock.
Micron's DRAM business generates by far the most revenues for the firm. In FQ3'21, DRAM production and sales generated $5.4B in revenues for Micron… which was 52% more than last year and 23% more than in FQ2'21. The share of DRAM revenues expanded from 66% to 73% because of strong demand and pricing effects that supported Micron's segment growth. Micron's NAND business is taking a backseat for now due to favorable market factors and momentum building in the DRAM business. Longer term, I expect NAND products to generate accelerating revenues, starting in FQ4'21, based on the roll-out of Micron's 176-layer 3D NAND which, for example, powers its new Crucial P5 Plus solid state drives. The new gen-Crucial P5 Plus SSD offers 66% faster write speeds compared to the previous gen model and read speeds up to 6600MB/s. Micron's 176-layer 3D NAND has been invented for the purpose of dealing with high intensive workloads, typically related to demanding video games and engineering programs. The extent of customer uptake of Micron's new storage solutions will be seen in the next earnings release. Micron also said last week that it has begun volume shipments of its 176-layer NAND Universal Flash Storage/UFS 3.1 mobile solution which promises "up to 75% faster sequential write and random read performance" and "15% faster mixed workload performance" compared to the prior generations. The NAND UFS 3.1 storage solution is aiming at the lucrative 5G market that requires fast app launching times and super quick download speeds. With these moves in the NAND market, Micron's top line should see some acceleration beginning in the next quarter. NAND revenues contributed just 24% of all revenues in FQ3'21 and while momentum is on the side of Micron's DRAM business now, the NAND segment should not be underestimated as new product roll-outs could really make a splash if customer uptake is as strong as expected. Micron has been growing NAND-related revenues at a lower rate than DRAM revenues this year, but this might change in the future as Micron forecasts long-term NAND bit demand growth to be around 30% annually.
(Source: Micron)
Business strength in DRAM and NAND has led to record free cash flow for Micron in the last quarter. Micron's free cash flow soared to $1.5B in FQ3'21, in part due to lower investments in equipment, showing a 15-fold increase over last year. Based on momentum in DRAM and accelerating volume shipments in NAND, Micron could have a free cash flow of $1.6B or higher in FQ4'21.
(Source: Micron)
Because of this impressive growth, Micron is undervalued. Micron is now expected to have revenues of $37.0B next year which could result in more than $15.5B in gross margin dollars (assuming a 42% margin). This revenue growth costs a buyer only 7x projected earnings for next year which makes Micron's growth very cheap.
The market now also expects a revenue acceleration next year, strengthening the case for margin expansion as new NAND products are distributed into the market. Micron is expected to see about 30% revenue growth this year and 34% next year...
(Source: Seeking Alpha)
The dividend is nice, but doesn't really matter
Micron is initiating a dividend. The firm announced on Monday that its Board of Directors declared a quarterly dividend of $0.10 per share of Micron's outstanding Common Stock which is payable in cash on October 18, 2021. Based on this declaration, Micron's shares will yield 0.5%. The introduction of a dividend is likely meant to signal growing business strength and it marks a departure from the previous policy of "share buybacks only". As a shareholder, I want Micron to retain as much cash as possible and reinvest it into innovation and higher performance storage solutions. The dividend payout itself represents such a low dollar amount that it doesn't really make a difference for shareholders unless a significant increase follows in the future.
Micron had $7.7B in cash on its balance sheet the last time it made a disclosure, showing that it can easily afford to pay the dividend. Strong end markets and improved pricing will likely continue to improve Micron's cash position this fiscal quarter.
(Source: Micron)
Risks with Micron
Micron is seeing strong growth in its DRAM business, and NAND is just about to pick up momentum. This promises continued strength in bit shipments and ASPs. But, slowing ASP growth and decelerating revenue growth would likely be perceived as a cyclical threat to margins which could add pressure on Micron's valuation. Declining DRAM ASP strength, slowing revenue growth in DRAM, weakening end markets in either DRAM or NAND, and slowing growth in bit shipments are major risks for Micron that could indicate stronger headwinds for Micron's stock.
Final thoughts
The dividend is not a reason to buy Micron, but the memory chip maker's growth is. I expect DRAM end markets and ASPs to remain strong for a couple more quarters before DRAM bit shipments slow as the market works to correct the supply shortage. However, Micron's roll-out of new 176-layer NAND products, which promise much better performance for 5G-capable smartphones, could create a new catalyst for Micron's revenue acceleration next year. Micron's gross margins have not peaked yet... and this makes Micron a buy even without a dividend!
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of MU either through stock ownership, options, or other derivatives. 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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