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Micron Stock: Concerns About Its Finances Are Overdone

Mark R. Hake

Micron Technology (NASDAQ:MU) has done an excellent job of managing its finances in the present semiconductor industry downturn.

Micron Stock: Concerns About Its Finances Are Overdone

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A closer look shows Micron stock can withstand this turbulence just fine. It has plenty of net cash and has managed to convert its net income to free cash flow.

Micron’s Huge Cash Pile

For example, even though MU’s sales fell 15% from $21.9 billion to $18.5 billion during the first nine months to May 31, MU has actually increased its liquidity. Net cash (after all debt), securities and investments rose 11% from $2.7 billion at the beginning of the year to over $3 billion:

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The reason: free cash flow has been managed extremely well. Here is what they have done:

  • Spent 17% more on capital expenditures than last year’s first nine months
  • Used 81.6 of free cash flow to buy back shares
  • Made $576 million on debt repayments
  • Used $1.3 billion more than available free cash flow, yet net liquidity rose to $3 billion.

This can be seen in the table below:

How did Micron’s liquidity actually rise even though its change in cash was -$1.3 billion for the first nine months? The answer, they bought securities. The table below shows this:

This shows that the company increased its balances of securities by $1.2 billion. Note how that corresponds to the column “Bought Securities” in the previous table of -$1,249 million. The difference probably lies in the valuation of the securities being lower at the end of May 2019.

Here is the main point, despite a huge decrease in sales and free cash flow for the year so far, Micron has managed its liquidity extremely well.

To understand this better, let’s take a look at how it makes its free cash flow.

Free Cash Flow Conversion

Analysts like to use a term called “Conversion” when describing the ability of a company to convert net income into free cash flow (sometimes they use it to mean converting Sales or EBITDA into free cash flow, as well).

Looking Micron’s free cash flow conversion, the table below shows it has fallen a lot:

So it Micron has only been able to convert 36.7% of net income into free cash flow. The reason is because it has fixed spending on capital expenditure and less working capital, including changes in inventory and receivables, to translate into real cash flow.

Note that the latest quarter’s conversion was only 75% of the prior quarter. We can use that number to estimate the upcoming August 30 free cash flow. Management has given us guidance.

Free Cash Flow Estimates

On June 25, Micron management gave very explicit guidance about its upcoming fourth quarter:

Since sales will only be 6% lower based on this guidance, we can revise the conversion factor to about 45% (based on an adjustment of the 75% conversion ratio above), and then estimate free cash flow.

So even with lower sales and net income, Micron will make positive free cash flow. This will increase the MU’s liquidity even further, all other things being the same.

Management recently said at a recent conference indicated that it is starting to see demand coming back in a meaningful way. So there is every likelihood that the net income and free cash flow estimates will be on the higher side of these estimates.

Why Is Free Cash Flow So Important?

Free Cash Flow feeds into the company’s net liquidity, which makes up a substantial part of its shareholders’ equity or book value. For example, MU’s book value grew last quarter from $33.1 billion to $36.1 billion, even though sales growth was negative, as we showed above.

In fact, as long as MU stays free cash flow positive, the book value will tend to grow, unless it has a huge drop in the value of its inventory valuation, which is not likely.

Targeting Price-to-Book Value

Micron stock tends to trade around its price-to-book value ratio (P/B). For example, right now its market value is book value per share is $32.02 ($36.1 billion book value dividend by 1.13 billion estimate diluted shares outstanding. So its P/B is 1.35 times.

Assuming MU book value grows again due to positive free cash flow as we have shown and higher net liquidity balances in this coming quarter, MU stock will likely trade higher if the ratio stays the same.

At its peak price last year, MU traded for over 2.2x P/B, and at its low 1x P/B. On average it traded for 1.63x its book value. Based on my forecast of positive free cash flow this year, the book value will reach $32.02 per share.

Using last year’s average P/B ratio, and assuming MU’s product demand continues to improve, Micron stock could reach over $52 per share this year.

What to Do?

Don’t get overly concerned about what you read about Micron’s finances and inventory issues. The company has proven it can handle demand downturns in its semiconductor business and still make positive free cash flow.

At today’s price the stock is likely to do well based on its average price-to-book value trading in the past.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities.

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