- Micron’s recent momentum is driven by pricing recovery.
- These trends remain intact, given enterprise adoption and refresh of consumer devices.
- Furthermore, recent trends support a substantial earnings beat in Q4’16.
Believe it or not, things could quickly turnaround for Micron Technology, Inc. (NSDQ:MU), as the timing of demand recovery for NAND flash could happen a lot quicker than what investors were originally anticipating. Furthermore, the pricing trends are at least supportive of a recovery in the immediate time frame.
As such, I’m taking a more definitive stance on this particular company notwithstanding the potential risk of diminished sentiment going into the next expansion cycle. Given the cyclicality of the business model, it’s likely that investors are getting wary of investing in the trough parts of the business, hence it will likely trade at a discounted valuation when compared to the tech peer group, but in-line with semiconductors. As such, much of my thesis is based on the potential expansion of top/bottom line as opposed to multiple expansion.
The market for NAND is starting to recover
DRAM pricing improved by 17% from the lows in June to the beginning of August, according to DRAM eXchange. Given the rapid price improvement, it’s likely that we’re witnessing a sustained pattern of recovery, as the usage of NAND storage in the enterprise is expected to grow at a blistering pace. Furthermore, Micron’s high-dependency on market pricing suggests that fundamentals are heavily dependent on the spot pricing of DRAM/NAND.
Here were some additional insights shared by Stephen Chin from UBS AG:
But it is not clear if the more recent July contract trends saw further improvement. Our UBS supply/demand forecasts for the DRAM industry contemplates improving fundamentals with the potential for supply balance or tightness into C2H16. This is due to moderating supply growth as industry capex spending on new capacity has also slowed.
Given the blip in pricing, it’s not an established trend. However, the right ingredients for a sustained ramp are emerging given the rapid scale back of CAPEX among the major memory/storage providers, and the emergence of new use cases. While flash prices could be falling due to structural issues (better efficiency/yields), the investment thesis hinges on whether Micron can return gross margins to respectable levels, which is starting to become a more realistic possibility.
Some quick figures from a Credit Suisse report: NAND flash trends are projected to grow at 44% CAGR between 2015 and 2020. While pricing is a key component of SSD adoption, the improved speed and reliability of SSDs is sustaining heightened speculation over the continued adoption of All-Flash arrays.
Performance computing in the data center is driving much of the adoption, with further potential for SSDs (solid state disk) to replace HDDs (hard disk drives) in cold storage. To be more specific, industry forecasts imply that SSDs will represent 85% market share for mission critical workloads, but capacity driven applications will grow to 10% of the market from 5%. But, the analysts at Credit Suisse believe the 5% to 10% forecast for storage intensive applications to be too pessimistic, which is in-line with my thought process given rapid improvements in pricing, and reduced energy consumption.
SSDs are anticipated to compose 66% of NAND consumption from 42% according to industry projections. This implies that SSDs as a percentage of HDDs will continue to ramp higher. The below table tries to summarize this.
In the table above, Credit Suisse is anticipating that storage will grow on aggregate at 45% annually over the next four-years. However, there are some discrepancies between what the industry anticipates as SSD share versus Credit Suisse. At 10% total SSD versus HD storage share, the SSD component should grow at a 35% rate annually (the industry wide estimate). However, in the more optimistic scenario, Credit Suisse is anticipating that SSDs will compose 25% of the total storage exabyte mix, which is 15 percentage points higher than industry expectations.
Given the rapid improvement in cost efficiency for next generation NAND, I'm anticipating the cost per/GB to continue to decline and reach cost parity with HDDs over the next five to ten years. I'm also anticipating new data consumptive technologies such as autonomous computing to drive heightened adoption of SSDs due to the need for denser storage and faster read/write speeds. As such, 25% SSD share seems realistic, as technological adoption tends to move at an exponential pace.
Near term earnings catalysts
It was mentioned in a recent Oppenheimer report that the recent trends in pricing are supported by healthier demand from device OEMs, most notably Apple, Inc. (NSDQ:AAPL). In other words, the pricing recovery in the immediate term is fueled by consumer devices, and will eventually transition to reflect further penetration into the enterprise SSD market. The discrepancy in the current year is due to the upcoming iPhone 7 line-up, which will start with a higher base and maximum storage configuration.
Here’s the key highlights from Oppenheimer & Co. analyst Rick Schafer on flash vendors:
NAND flash vendors have increased chip prices, citing strong demand for new smartphones particularly the iPhone 7 featuring up to 256GB of storage, according to industry sources. Prices will keep soaring until the fourth quarter of 2016, they predicted. On the other hand, if sales of the new iPhone disappoint, NAND flash prices could start falling in the first quarter of 2017, the sources warned.
Given Micron’s conservative guidance of $2.9 billion to $3.2 billion revenues for Q4’16 in conjunction with gross margins of 15.5% to 18%, it’s likely that the company will report a substantial earnings beat, as the recent pricing improvement was not reflected in the guidance figures. Channel sell-in of the iPhone 7 starts within 6-week prior to launch, which will drive pricing higher in the months of August and September. Furthermore, the recent improvement in pricing between June and August is also not factored into either Micron's gross margin or revenue estimate.
Source: Alex Cho
I’m anticipating 20% q/q revenue improvement partially supported by organic demand growth, but mostly by pricing. The gross margin figure should recover to appx. 20% given the recent improvement in NAND pricing, and reported pricing gains for vendors in response to 256 GB iPhone demand.
My operating expense estimate is at the mid-point of management guidance, and my tax rate assumption of 8% is low due to the net operating loss carry forwards from a sustained period of operating losses, and comparative tax estimates from other sell-side models. I believe the share count will remain constant, as a dilutive event has yet to occur.
Given these assumptions, I’m fairly certain that diluted EPS of $0.06 is attainable, which is substantially higher than the consensus estimate of $-0.18 for the upcoming quarter. My estimate is well beyond the high-end of the range, but given the high probability of ASP improvement, and above historical gross margin expansion, I have high conviction that Micron will knock it out of the ball park.
I feel compelled to reiterate my high conviction buy recommendation on Micron Stock.
The stock will exhibit substantial gains prior and post the earnings announcement. Since the stock is trading on near-term fundamental strength, timing becomes less of an issue. Furthermore, industry trends provide long-term visibility and support a narrative of cyclical strength for 3D NAND.
Given a further density of storage in flash arrays, there’s meaningful adoption potential for Micron’s next-generation memory/storage. Since Micron is positioned to capture this market opportunity due to its upcoming Dalian Facility, the long-term investment thesis remains intact.
Therefore investors should buy and hold Micron stock. I will assign a price target in a future Micron article.