Micron: PC And Mobile Headwinds Could Cause More Pain

May 15, 2022 9:28 PM ETMicron Technology, Inc. (MU)SSNLF101 Comments10 Likes

Summary

  • Micron presented its long-term model at its recent Investor Day. But, there weren't any positive surprises, even though it offered helpful insights into its long-term profitability.
  • We think Micron's near-term profitability could have peaked. In addition, the headwinds in the PC and mobile segment could continue to hinder MU stock momentum.
  • We revise our price target to $80 from $100. As a result, we also revise our rating from Buy to Hold due to a less attractive risk/reward profile.
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Micron headquarters in Silicon Valley

Sundry Photography/iStock Editorial via Getty Images

Investment Thesis

Micron Technology, Inc. (NASDAQ:MU) held its investor conference recently and management presented insights into its long-term model. It also discussed its transition from mobile and PC into the higher-margin data center, automotive, and industrial segments.

We think Micron has presented a credible thesis that it can execute confidently while maintaining reasonable expectations. While we remain confident about Micron's strategy, we are still cautious about the industry's inherent volatility. Management has telegraphed its move toward longer-term agreements (LTAs) to mitigate the volatile price swings resulting from seasonal cycle dynamics.

Investors should note that such price swings have significantly impacted the memory leaders' profitability in the past. As a result, the market remains cautious in re-rating the memory makers' valuation in line with the semi-industry mean. In other words, Micron and its leading memory peers, SK Hynix and Samsung (OTC:SSNLF), are cheap for a reason. Therefore, we believe that the market will continue to ascribe lower valuation multiples to MU until it's convinced that their LTAs have proven significant to sustain their margins through the up and downcycle.

We also note that MU stock has continued to face selling pressure at the two significant bull trap levels at around $100. Therefore, we reduce our price target to $80 (implied upside of 11.2%). We noted that MU stock could continue to face selling pressure if it could not maintain its current support level. As a result, MU stock could face a potential downside of 20% to 35.7%. Notably, we also have not observed any bear trap that could potentially strengthen the buy point at the current support level.

Consequently, we revise our rating on MU stock from Buy to Hold, given the less attractive risk/reward profile due to our PT downgrade.

Peak Margins Worry The Market

Micron presented its long-term model at its recent conference, which was helpful and corroborated our views that MU margins could be peaking in the near term. Micron presented a long-run revenue growth rate in the high single digits, as it expects to outpace the industry's growth. Micron posted LTM revenue growth of 24.9% in FQ2. Therefore, investors should factor in a potential topline growth deceleration moving forward. We believe the significant exposure to the slowing PC and mobile market could continue to be a substantial headwind for its revenue growth as it exits FY22.

Notably, Micron's PC and mobile segments accounted for 55% of its CY21 revenue. Management estimates PC and mobile's revenue share to decline to 38% by CY25. However, it implies that Micron's revenue remains highly susceptible to the current PC and mobile headwinds for CY22.

Micron LTM FCF margins %

Micron LTM FCF margins % (S&P Capital IQ)

Micron LTM gross margins % and EBIT margins %

Micron LTM gross margins % and EBIT margins % (S&P Capital IQ)

Furthermore, the significant volatility in Micron's profitability and FCF margins has continued to spook investors. Analysts also sought management's guidance on the profitability guidance of its long-term model. They also wanted to know whether Micron could potentially head back to the higher margins days of 2018. However, CEO Sanjay Mehrotra was reticent in providing additional color. Instead, he emphasized (edited):

So we have projected cross-cycle margins. We are not projecting peak or trough. And the point again is with less volatility, there will be greater stability in the industry as well. (Micron's 2022 Investor Day)

Notably, Micron guided for long-term operating margins of 30% and FCF margins of more than 10%. If we consider Micron's LTM EBIT margin of 33.6% and FCF margin of 15.6% in FQ2, bearish Micron investors could argue that Micron's near-term profitability could have peaked. But, of course, unless Micron could achieve significant operating leverage gains from much higher revenue growth or significant cost mitigations.

Micron consensus estimates %

Micron consensus estimates % (S&P Capital IQ)

Furthermore, we think the consensus estimates on its revenue growth could be too optimistic as Micron exits FY22. The Street's average estimates suggest a 20.8% YoY revenue growth in FY23. However, the most conservative estimates were much less sanguine. They indicate that Micron could suffer a YoY revenue decline of about 4.5% in FY23. Notwithstanding, we believe these projections could be too pessimistic, given the company's exposure to secular growth drivers in automotive, industrial, and data centers.

However, the continued weakness in the PC and mobile market could be more significant than estimated. Given Micron's current exposure, and its current estimates, we believe a de-rating could occur. Therefore, we encourage investors to continue monitoring the PC and mobile market trends carefully moving forward.

MU Stock Price Action Is At a Critical Juncture

MU stock price chart

MU stock price chart (TradingView)

MU stock price chart (monthly)

MU stock price chart (monthly) (TradingView)

MU stock had two significant bull traps at the $100 level. Therefore, investors are urged to avoid adding anywhere near that level. If possible, they should loosen their exposure if MU stock goes toward that level subsequently. As a result, we cut our PT to $80, which is MU stock's most recent resistance level.

Furthermore, we believe that the market is still digesting its massive gains from 2020, as it drew in the buyers rapidly. The enormous bull traps at $100 corroborated our thesis that MU stock would continue to face near-term headwinds. As the stock last traded at its critical support level of $65, selling now would not be reasonable.

Therefore, we urge investors considering adding exposure to wait for a re-test of its current support level. We believe that MU stock could face a potential downside of between 20-35.7% if the market makers decide to digest its gains further. Also, note that MU stock has already broken well above its 2018 highs, even though its profitability is nowhere near those levels. Therefore, it looks increasingly likely that MU stock has likely priced in its optimism.

Is MU Stock A Buy, Sell, Or Hold?

MU stock NTM FCF yields %

MU stock NTM FCF yields % (TIKR)

MU stock last traded at an NTM FCF yield of 9.5% (Vs. 5Y mean of 9.12%). It's also more attractive than its memory peers SK Hynix (KRX: A000660) and Samsung stock (KRX: A0005930).

However, we explained previously that the re-rating in MU stock is unlikely in the near term given its volatile margins profile. The market must be convinced that the industry profitability can improve dramatically moving forward. Otherwise, MU stock valuation is likely to stay lower than the semi-industry average.

We revise our rating on MU stock from Buy to Hold with a PT of $80. We are not bearish on MU stock. But, with an implied upside of 11% and a potential downside of 20-36%, we think the risk/reward profile is tilted to the downside. Consequently, we encourage investors to wait for a better buy point before adding exposure.

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