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When It Comes to Micron Technology, Inc., Bull Beats Bear

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Luke Lango
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After a red-hot 2017, chipmaker Micron Technology, Inc. (NASDAQ:MU) has had a rough start to 2018. Thanks to resurgent fears related to DRAM and NAND pricing trends, Micron Technology stock is more than 20% off its recent highs.

But the sell-off seems overdone.

My thesis on Micron stock has been quite simple. This is a “music” stock. You want to buy this stock when the music is playing, and you want to sell this stock before the music stops playing.

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It’s that simple.

As it relates to Micron stock, the “music” is the company’s underlying supply-demand fundamentals. When supply-demand fundamentals in the company’s core DRAM and NAND markets are favorable (high demand, low supply), then the music is playing, and Micron stock heads higher. When those same supply-demand fundamentals start weakening (lower demand, higher supply), then the music starts slowing, and Micron stock stalls out.

And when those supply-demand fundamentals get ugly (low demand, higher supply), then the music stops, and Micron stock drops like a rock.

Right now, there are some concerns that the music is slowing. Those concerns are valid.

But the current stock price reflects expectations for the music to stop playing all together in the near future. I don’t see that happening, and as a result, I’m a buyer of Micron Technology stock here and now.

Music Is Still Playing for Micron Technology Stock

There have a been of upgrades and downgrades on Micron stock over the past few months as analysts engage in this constant tug-of-war over when DRAM and NAND pricing trends will become unfavorable. The bears got some ammunition recently amid weak high-end smartphone demand (thanks, iPhone X) and some cautious commentary from Apple Inc (NASDAQ:AAPL) which projected DRAM and NAND prices to fall in the near future.

That will probably happen. DRAM and NAND prices will likely erode over the next several quarters and years as supply ramps amid a weak demand backdrop for smartphones and PCs.

But this erosion will be of the gradual kind, and DRAM and NAND prices will still be far above historical levels.

Why? Two reasons.

First, demand is currently unprecedented, and will continue to remain robust into the near future. Smartphones and PCs aren’t the big demand drivers anymore. Currently, the big demand drivers are cloud and the Internet-of-Things (IoT), two drivers which are showing zero signs of slowing down. In the future, the big demand drivers will be automation and artificial intelligence, two huge end-markets that are still in their early innings.

Thus, demand should remain strong into the foreseeable future.

Second, supply will remain constrained relative to that big demand. Samsung recently reiterated that they are focused on maximizing profits, not building out capacity and gaining market share. That seems to be the mindset of most players in this market. As long as that remains the case, supply will remain constrained, and profits will remain high.

Overall then, while the music is slowing for Micron stock, it certainly isn’t ending all together.

Micron Technology Stock Is Undervalued

Owing to the tug-of-war between analysts on whether or not DRAMD/NAND prices will fall over the next several years, there is a wide range in earnings estimates over the next several years. Nonetheless, the consensus calls for peak earnings this year and eventual earnings erosion over the next two years.

This is nothing new. Earnings have peaked before.

Back in 2010, earnings peaked around $1.85 per share. By 2012, earnings had fallen to a loss of about $1 per share.

In 2015, earnings again peaked, this time around $3.25 per share. By 2016, earnings had fallen to a loss of about $0.30 per share.

In both of those cases, the raw earnings collapse from peak to trough was roughly $3 to $4 per share.

Earnings are projected to peak this year around $11 per share. If we extrapolate a similar $3 to $4 earnings collapse, then earnings should wind up around $7 per share in fiscal 2020.

A historically-normal 9-times forward multiple on those $7 earnings implies a 2019-end price target of $63. Discounted back by 10% per year, that equates to a present value in the lower $50s.

Thus, it appears as though Micron stock in the upper $40s is priced for an unrealistically large collapse in earnings power. Such an unrealistically large earnings collapse won’t happen because supply-demand fundamentals in the DRAM and NAND markets will remain largely favorable into the foreseeable future.

Bottom Line on Micron Technology Stock

This isn’t a stock to buy and hold forever. But it is a stock to buy here and now.

There are risks to the supply-side fundamentals in the NAND and DRAM markets, but such risks seem overly priced in with the stock hovering in the upper $40s. As such, this looks like a good time to buy while fears are high.

As of this writing, Luke Lango was long MU and AAPL. 

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