- Micron Technology Inc. appears to be a great contrarian buy at the current levels.
- Expect higher ASPs, bit growth and better margins going forward.
- There are several positive catalysts that can drive Micron's growth ahead.
Shares of Micron Technology Inc. (NASDAQ:MU) have been beaten down post-earnings even though its bottom-line results slightly exceeded the analyst consensus prevailing at the time. The market appears to have sharply reacted (on the downside) to its lowered guidance and recently announced layoffs. But this bearish sentiment may be short lived. I believe the company has several positive catalysts in store that could trigger a major rally in its shares over the course of the current year (2016). Let’s take a closer look at why Micron makes a great contrarian play.
DRAM Pricing Improvement
Let me start by saying that Micron has a huge exposure to the DRAM industry; the company generates about 70% of its revenue from the sales of DRAM modules. This lack of diversification and over-dependence on one segment particularly weighed down on Micron over the recent quarters as DRAM prices have been distressed lately. Samsung has been aggressively increasing DRAM output at competitive prices over the recent months, in a bid to gain market share, which caused DRAM prices to plummet. The chart below highlights that.
The situation in the last quarter was such that after posting 22% bit-growth YoY, Micron managed to record only 9% growth in DRAM revenue. This discrepancy occurred primarily due to a weak pricing environment. Market participants just saw the revenue figure and got disappointed without paying too much attention to the fact that Micron was able to deliver a robust bit-growth amidst slowing down PC and smartphone sales.
Now, what if DRAM prices recovered? Higher ASPs at higher bit volume should technically catapult Micron’s topline growth, right? I believe this is a more likely scenario for Micron. DRAMeXchange published a report last week stating that DRAM module prices have stabilized and could see a 4-8% increase by the end of Q3; increasing demand from mobile and server applications will be the key demand growth drivers. This information wasn't available when Micron posted its Q3 results.
After factoring-in a bit growth of about 25% in Q4, and an average 6% ASP rise, I believe Micron’s Q4 DRAM revenue could very well see a boost of 32% sequentially over the Q3 figure. If we talk about a range, then Q4 DRAM revenue growth could be anywhere between 26% and 38% sequentially. These are pretty robust growth rates for a company that is being lambasted by market participants over its Q3 revenue miss.
Delay in the acquisition of Inotera was another factor that was causing a drag on the company’s stock. It was earlier expected to complete by mid-July but the company announced approximately 3 weeks before the announcement of Q3 results, that the acquisition had been delayed:
“While the acquisition was initially expected to close in mid-July 2016, the parties have concluded that closing the transaction on this timeframe is not possible.” – Micron’s press release on June 8, 2016.
The delay meant that financial benefits of the acquisition would take longer to roll in and that Micron would take longer to become profitable again. The markets sharply reacted to this news and, as a result, shares of the chipmaker plummeted 10-15% in June.
But this event is something that is bound to happen; it has merely been delayed. If it didn’t happen in mid-2016, it will happen later on as the acquisition hasn’t entirely been called off. At best Micron didn’t collect Inotera’s two quarters worth of revenue. This isn’t something that would cause a permanent drawdown on any company’s stock. Given its currently distressed stock price, I’m confident that Micron’s board will be moving aggressively to complete the acquisition by 2016-end to keep investors happy.
I’m expecting a zealous market sentiment in Micron going forward, with respect to the Inotera acquisition.
The key thing to note is that Micron is still in the process of ramping up its 20nm production. It’s a smaller node that promises a higher chip density, but more importantly, offers lower production costs. The chipmaker has moved about half of its DRAM production to the 20nm node, whilst the remaining half is still on 25nm and 30nm nodes. What does this mean for investors?
Well, Micron was able to lower its cost-per-gigabyte by 22% over the last two-quarters alone, primarily by moving its production to the 20nm node. As the chipmaker gradually shifts the remaining half of its production to the 20nm node over the coming quarters, these cost benefits will continue to roll in. Naturally, another 20-25% reduction in its cost-per-gigabyte in the near future would have a big positive impact on its bottom-line.
The chipmaker also has its 1x node in store; this is believed to be a 16-18nm node and offers another 20% cost benefit compared to the 20nm node. This pretty much suggests that we could see a sustainable improvement in Micron's cost-per-gigabyte and gross margins over the next year also.
Micron has been struggling due to falling DRAM prices but the worst appears to be behind us. With DRAM-related pricing environment soon expected to change, and ASPs projected to rise, shares of the chipmaker might start rallying again soon. We can expect a sustained growth in bit volumes as the world moves on to the new DDR4 standards. I believe that higher ASPs, lower production costs in addition to $80 million/quarter of cost savings could drive Micron’s profitability significantly higher.