U.S. Markets close in 3 hrs 32 mins

Micron Stock Is Getting Cheaper, but Don’t Buy Until This Happens

Ian Bezek

Thanks haven’t been great at Micron (NASDAQ:MU), but there’s hope yet for Micron stock.

There are some fundamental, unchanging laws: Supply and demand; self-interest makes people work harder; competition causes firms to make better products cheaper. Oh, and that semiconductor stocks are eternally cyclical and will get absolutely pulverized every couple of years.

Micron in particular is no stranger to the semiconductor cycle. Starting in 2012, it went on a breathtaking run, with shares appreciating 600% in two years. It then proceeded to lose three-quarters of its value.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

From the 2016 low, Micron stock rebooted, and ran up 500%, nearly matching the unbelievable 2012-14 move. Alas, MU stock has hit the wall again, losing half its value since June of this year. What happened?

Guidance Fiasco

MU stock continued its recent tumble following its Q1 earnings release on Dec. 18. It wasn’t because of the reported numbers, however. Earnings came in just ahead of analyst forecasts. Revenues did come up short of expectations, but it was a tiny miss.

No, the real problem was its shocking Q2 guidance. Management forecast $5.7 billion to $6.3 billion in revenues for the next quarter. That was a stunning number, as analysts had expected something closer to $7.2 billion in revenues. How will Micron end up coming up close to 20% short of analyst expectations?

The problem with cyclical industries is that analysts and investors are usually too slow to react. Analysts in particular tend to forecast based on models. These models, in turn make a lot of assumptions that are generally based on linear progression.

Growth happened at this rate over the past quarter or year, so if you extrapolate that out, here’s where you end up next year, and so on. With semiconductors, however, this sort of modeling is difficult as demand fluctuates so quickly.

Applied Optoelectronics (NASDAQ:AAOI), a semi-play in the communications equipment space, was a recent dramatic example. Their stock was at $10 in 2016, hit $100 in 2017, and is now back at $15. How’d it happen?

Once the company won a few big contracts in 2016, analysts projected more such wins for years to come. In 2017, the company announced one major client was leaving. The stock dropped 25% on the news. But it should have been far more. Once the cycle turned from new clients and growth to shrinking revenue, the party was over.

The same issue happened here for Micron and its competitors. Throughout 2018, there were whispers of concern that demand was starting to fade. Yet analysts remained optimistic for too long, focused on trailing earnings and present cash flow rather than the future outlook. That’s how you got such a dramatic drop in the back half of 2018 as reality suddenly invalidated prior expectations.

Stronger Balance Sheet A Big Plus

Regardless of how badly this cycle ends up, Micron stock is unlikely to return to the depths of 2012 or 2016. That’s because Micron now has more cash than debt. That’s in stark contrast to, say, 2016 when it had $4.4 billion in cash against more than $9 billion in debt.

As a matter of fact, despite its plummeting stock price, the credit rating agencies are giving a favorable look at Micron’s affairs. Just two weeks ago, S&P announced that it is looking at upgrading Micron’s debt. It currently gives Micron a BB+ rating, which is considered junk debt, albeit the highest tier.

S&P now views Micron as potentially worthy of an investment grade rating. Even a mere one notch upgrade would move Micron to BBB-, and into investment grade territory. S&P has some stipulations for whether it will in fact deliver the upgrade in 2019 such as the company retaining a net cash position.

Regardless, S&P stated that Micron has shown: “substantial operating improvement and debt reduction.” It’s worth remembering that positive outlook from an influential source as Micron stock continues to slump in the short run.

It’s worth considering one other point on this topic. Unfortunately Micron struggles with allocating capital. It issued ugly 7.5% convertible bonds back when it was under duress during the last cycle. It then, mysteriously, issued stock in late 2017 to pay off part of these bonds at a significant premium to par just as interest rates were starting to surge.

In May 2018, with the stock approaching its highest level in many years, the company announced a massive $10 billion buyback.

To sum up, the company issued debt at a bad time, bought it back at a higher price by selling new stock, and then repurchased that stock at higher prices just months later. A company like Micron should issue debt during good times when it can get reasonable interest rates and save that cash hoard to buyback stock when the cycle turns. They, instead, do the opposite.

Micron Stock: Will Bounce, Eventually

Despite the plunge in memory demand and management’s dubious capital allocation strategy, things will still turn around, eventually. Unfortunately, there’s nothing in the short run that would indicate that things are about to get better for Micron stock.

The company’s guidance was flat-out awful, and it’s hard to imagine analysts will get their estimates down fast enough for the rest of the year either. It will be hard for Micron to pull off a sustained rally until earnings start to stabilize.

That said, the memory chip cycle plays out fairly quickly. In the past, we’ve seen two year waves, but it could come even faster now that demand seems to be a little more sticky. Bulls have said the cycle is largely dead, bears said it was as strong as ever, but the truth is in the middle.

Once you see the first sign of positive demand recovery, it will be time to buy Micron stock again. We can’t know when that will be, but it could come within the next couple of quarters. That will be the time to hop in for another bullish trade as the Micron stock roller coaster starts moving upward again.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

More From InvestorPlace

Compare Brokers

The post Micron Stock Is Getting Cheaper, but Don’t Buy Until This Happens appeared first on InvestorPlace.