- Fundamentals look favorable for Micron going into 2017. Fourth quarter earnings projections have already been raised by the company.
- Demand is coming back for PC DRAM memory. This has lifted prices accordingly.
- Transition to 20nm node and 1x node will bring down costs even more in the DRAM space.
Micron Technology, Inc.(NSDQ:MU) has had some run since May of this year. The stock is up 75%+ and I believe there is still room for more in this rally. The company announces its fiscal fourth quarter earnings on the 4th of October and the management is bullish in its expectations. Micron had predicted revenues of between $2.9 billion and $3.2 billion for the fourth quarter but has stated as recently as last week that it should now meet the upper end of its guidance which is bullish considering the negative sentiment that surrounded this stock after Q3 results were reported. In fact, just a few short months ago, Micron had to report a restructuring plan (where $300 million of savings are estimated) in order to compete and return to growth in a fiercely competitive industry.
How quickly things can change. Micron has also been boosted recently by Intel Corporation's (NSDQ:INTC) recent guidance hike where the latter believes an uptrend in PC sales is on the way due to demand improving. DRAM sales have been a dead duck for Micron in recent quarters, which has resulted in most chip makers focusing more on NAND. However, Micron more so than its competitors has continued to keep production elevated in the DRAM space and it looks like it is going to pay off due to lower costs and higher industry demand.
In terms of trading or investing in this stock, investors should be aware that the stock is highly volatile and unpredictable. Furthermore, Micron doesn't have distinct competitive advantages due to the commoditized nature of the industry. Therefore, even though my thesis on this stock is currently bullish, fundamentals (due to supply and demand imbalances) can change on a whim in this industry. Hence, investors should definitely use a trailing stop loss as downside risk in the share price is always a distinct possibility.
What is going to drive Micron stock forward will be meaningful top and bottom line growth. These trends were definitely missing at the end of the last quarter, when Micron posted a revenue decline of $995 million and a profit decline of $706 million compared to Q3-2015. All Micron can concentrate on is getting its own costs and inventory levels in order. This is crucial and in the current DRAM market for example, we can really see how Micron delicately plays the supply and demand imbalances which are currently at play.
Demand Has Spiked Due To Samsung & SK Hynix Stalling Production
DRAM is an area where Micron's fundamentals definitely look bullish at present. Samsung and SK Hynix stalled their DRAM production in July because of saturation in the market, but the fundamentals have changed. Since then, we have seen a rebound in DRAM prices due to higher demand and Micron has the most to gain by keeping its production elevated. Remember Micron derives around 60% of its top line for DRAM sales, so this is a key area for the company.
We Saw In Q3 That DRAM Costs Are Coming Down
So now that DRAM prices have stabilized, Micron must be ruthless in getting its costs down in order to return to meaningful growth and profitability. We saw some encouraging signs in the third quarter where gross margins only dropped by 2% in the face of DRAM prices dropping by 11%. This means we are seeing a healthy improvement in cost basis. There should be more improvements in the near term. Micron is currently transitioning to the 20nm node and the 1x node which should improve the cost basis by a further 20%. Rising demand (which will boost prices) for DRAM and fatter margins look to be on the cards for Micron in the near term. However, a spike in production from the likes of Samsung would derail these fundamentals and this is something investors must watch.
Micron Now Needs To execute And Manage The Supply Side Of DRAM Well
So here is how I see Micron playing the DRAM market going forward. To keep demand buoyant, it will probably only increase its supply at a snails pace to keep up with this demand. Remember, this industry is all about controlling inventory levels, which protects the company's profit margins. The only way I would see competitors coming back to meaningful DRAM production would be if there was a spike in demand which consequently means a spike in prices. Micron can't let this happen. It now has a foothold in this market. It needs to execute and manage accordingly.
To sum up, Micron has positive fundamentals in the DRAM market at present. Although 3D NAND will become the future, we are not there yet and DRAM demand has shown this. Micron derives around 60% of its sales from DRAM. We should see an excellent fourth quarter which should provide the momentum for 2017. $20 a share should be easily doable here as long as the fundamentals don't change.