U.S. Markets open in 7 hrs 33 mins

Lower Memory Prices Will Hurt These 3 Companies

Leo Sun, The Motley Fool

Memory chip prices could tumble next year and end the "super cycle" of rising prices that started in mid-2016. TrendForce's DRAMeXchange estimates that NAND prices will fall 10% sequentially in the third and fourth quarters of 2018 before falling further in 2019. The firm also expects DRAM prices to tumble 25% next year.

These declines were expected because the memory market is a cyclical, alternating between periods of shortage and surplus. However, the upcoming contraction could hurt chipmakers that profited during the two-year boom. Here are three companies that could suffer as memory prices decline.

A closeup of a stick of RAM.

Image source: Getty Images.

Samsung

Samsung (NASDAQOTH: SSNLF) is the world's largest producer of NAND and DRAM chips. It controls over a third of the NAND market and almost half of the DRAM market. Samsung sells its memory chips through its DS (Device Solutions) segment, which produces components (mostly memory chips and displays) for OEMs.

Samsung's memory chip revenue rose 33% annually last quarter, accounting for 67% of its DS revenues and 32% of its total revenue. That's up from 23% of its total revenue in the prior year quarter.

The DS unit also generated a whopping 79% of Samsung's operating profits during the quarter, compared to 69% in the year ago quarter. Operating profits from semiconductors accounted for 99% of the unit's operating profits (Samsung doesn't report memory chip profits separately), so it's selling its displays at paper-thin margins.

High memory prices help Samsung offset the softer sales growth of its CE (consumer electronics) unit and the declining profits at its IM (IT & Mobile Communications) unit, which is being throttled by tougher price competition in the smartphone market. If those prices decline, Samsung's top and bottom line growth will suffer.

Micron

Micron (NASDAQ: MU) is the fourth largest NAND maker and third largest DRAM maker in the world. Unlike Samsung, which is diversified across multiple markets, Micron is considered a "pure play" on memory chips.

This has made Micron a red-hot stock since mid-2016. Its revenue fell 23% in fiscal 2016 due to weak prices in the first half of the year, but soared 64% in 2017. Wall Street expects its revenue to jump another 49% in fiscal 2018, which ended on Aug. 31. But looking ahead, Micron's revenue is only expected to rise 8% in 2019 as prices decline.

Goldman Sachs analyst Mark Delaney recently downgraded Micron from "buy" to "neutral" on those headwinds, warning that "incremental weakness in both DRAM and NAND fundamentals" would hurt the chipmaker's growth prospects. Delaney also warned that "memory downturns usually last for several quarters," with a possible "acceleration in price declines" as customers delay their purchases and wait for lower prices.

Two SSDs placed on top of a traditional HDD.

Image source: Getty Images.

Western Digital

Western Digital (NASDAQ: WDC) evolved into a major NAND player after its acquisition of SanDisk in 2016. It's currently the third largest NAND maker in the world after Samsung and Toshiba's memory unit, which was recently acquired by a US private equity group led by Bain Capital.

WD expanded into the NAND market to diversify its business away from traditional platter-based HDDs (hard disk drives), which were gradually being replaced by cheaper NAND-based SSDs (solid state drives). SSDs are smaller, faster, more power efficient, and less prone to damage than HDDs.

It's hard to gauge the exact impact of lower memory prices on WD's sales, since the company doesn't disclose its SanDisk memory chip and SSD sales separately. However, we know that SanDisk generated $5 billion to $6 billion in annual revenues prior to the acquisition, which would equal over a quarter of WD's projected sales this year.

RBC Capital analyst Amit Daryanani recently downgraded WD's stock from "outperform" to "sector perform" and slashed his price target from $95 to $70 on lower NAND prices, which he expects to persist into 2019 and compress the company's margins. Ironically, lower prices would have become a tailwind if WD hadn't bought SanDisk and still relied on third-party NAND chips.

But mind the contrarian arguments and wild cards...

The bearish thesis on memory chipmakers is easy to understand, yet some investors remain bullish on memory prices. The bulls claim that a growing number of connected devices worldwide -- including Internet of Things (IoT) gadgets, smart home appliances, and connected cars -- will tighten up memory chip supplies and prevent a massive decline in NAND and DRAM prices.

On the other hand, the collapse in prices could be worse than anticipated if China moves forward with its plans to flood the market with cheap NAND and DRAM chips. That would be great news for PC and smartphone makers, but it could crush memory chipmakers like Samsung, Micron, and WD.

More From The Motley Fool

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.