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Micron's Second-Half Recovery Now Looks Even More Unlikely

Timothy Green, The Motley Fool

Memory chip manufacturer Micron (NASDAQ: MU) is dealing with plunging prices, weak demand, and elevated inventory levels at some of its customers. The company expects a 38% decline in revenue and a 73% decline in adjusted earnings per share in its fiscal third quarter, results for which it will announce later this month.

The company admitted in March that pricing for DRAM chips -- a type of memory used in PCs, servers, and mobile devices -- had deteriorated more than expected. But it also continued to call for bit shipments to grow sequentially in the third quarter, driven by a pickup in demand.

That outlook may have been overly optimistic. DRAMeXchange, a division of market intelligence provider TrendForce, slashed its own forecast for the DRAM industry on Thursday due to the U.S. ban on Chinese tech company Huawei and the escalating trade war between the U.S. and China. Steep price declines are now likely to continue for the rest of the year, according to DRAMeXchange, and demand could dry up further in the second half as data center customers grow more cautious.

And despite consolidation in the DRAM industry, DRAMeXchange now believes manufacturers could see profitability turn negative before this cycle finally turns, as excess inventory is written off.

Shipping containers painted with U.S. and China flags.

Image source: Getty Images.

Get used to double-digit pricing declines

In the first six months of 2019, sales to Huawei accounted for 13% of Micron's total revenue. At a time when Micron's sales are already plunging, the loss of that business due to the U.S. blacklisting of Huawei is terrible news for the company.

The Huawei development led DRAMeXchange to adjust its outlook for DRAM pricing. In the third quarter, DRAMeXchange now sees DRAM average selling prices falling by 10% to 15% sequentially, down from a previous forecast of a 10% decline. For the fourth quarter, DRAMeXchange expects a 10% decline, much worse than the 2% to 5% decline previously expected.

These pricing declines are large enough that Micron's margins will continue to take a beating. When per-bit costs decline more slowly than per-bit prices, which will almost certainly be the case in the second half, margins contract.

DRAMeXchange also sees the U.S.-China trade war potentially leading data center customers to pull back on capital expenditures, which could "send demand in the second half of this year into quick-freeze." A price rebound in 2020 is possible, although it's far from a guarantee.

More pain ahead

Losses during downturns are nothing new for Micron. The company posted net losses in 2009, 2012, and 2016. Micron may manage to remain profitable this time around, although a return to red ink no longer seems implausible.

If DRAMeXchange's forecast is on the mark, pricing will remain tough in the second half, and the demand recovery Micron was expecting may not materialize at all. Thankfully, the company's balance sheet is much stronger today than it was during the previous memory chip downturn. At the end of February, Micron had $7.5 billion of cash, $1.6 billion of long-term marketable securities, and $6.2 billion of debt. That cash cushion will help Micron weather the storm, even if the company starts losing money.

Micron will report its fiscal third-quarter results on June 25. The only question is: How bad will the company's guidance be?

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Timothy Green 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.