Micron Technology, Inc. (NASDAQ:MU) has had an amazing 2017. MU stock is up 134% over the past 12 months, and 87% year-to-date. To be fair to Micron, they’ve earned this sort of run. The company’s earnings have been nothing short of breathtaking so far in 2017.
Throughout 2016, Micron barely made any money. In fact, they reported negative EPS three out of four quarters last year. However, earnings have delivered in 2017. The past three quarters have realized huge gains, rising from 90 cents to $1.62, and now $2.02 in the most recent earnings release. At that run rate, MU stock looks really cheap. If they could earn $2/share every quarter, they’d be making $8 a year, representing a 5 PE ratio on the current stock price.
At Micron, Things Are Good
All things are pointing upward for Micron at the moment. This past quarter soundly beat analyst estimates. The consensus had pegged the company at making $1.84/share. For the upcoming quarter, Micron projects another sequential earnings jump, with EPS rising to a range of $2.09 to $2.23. That’s solid growth from last quarter’s $2.02. And given Micron’s history of beating guidance, they should come in near the high end of the estimate.
Overall, analysts project Micron growing earnings to $6.13/share next year, which would put MU stock at under a 7x forward PE ratio. Raise your MU stock price target to $60, and you’re still at just 10x earnings. And some superstar investors are bored with Micron’s upside story.
Famous hedge fund manager David Einhorn is a big holder of MU stock. In his most recent quarterly letter, he said:
“[I]nvestors have reacted to MU’s improving earnings with a shrug. The company is now earning more than twice as much as it did at the peak of the last cycle […] While DRAM will always be cyclical, we believe investors are underappreciating the dynamics of the current cycle and the long-term structural improvements in the industry.”
PC demand historically has been the big driver for DRAM demand. Einhorn concedes that demand in PCs is “lousy”. However, he offsets this by noting that mobile phones and data centers now account for much more DRAM demand, and that these segments are strong. Furthermore, he suggests that Micron has advanced in front of peers on a technology and cost curve front.
But MU Stock Is Not That Good
Einhorn is a great investor. It’s wise to respect his opinion. In this case though, it’s worth remembering that he’s called Micron wrongly before. From 2013 to 2015, Micron stock shot up from $5 to $35. It subsequently collapsed back to $10, and Einhorn bailed on the way down before later reestablishing his position.
What went wrong that time? Micron initially did a poor job of integrating an acquisition, leaving them in a difficult position competitively against their peers. Throw in the move from Samsung Electronics KRW5000 (OTCMKTS:SSNLF) to boost capacity more than expected, combine it with weaker than expected PC demand and pricing pressures sent Micron’s earnings into a tailspin.
There’s no reason that past history will play out exactly again. But it goes to show just how cyclical this industry is. Investors thought Micron stock was worth $5 in 2013, $35 in 2015, and $10 again in 2016. Trends in demand for things such as data centers are virtually impossible to predict out past a few quarters. Look at the 60% decline in leading data center equipment company Applied Optoelectronics Inc (NASDAQ:AAOI) in four months if you want to see how this sort of cyclical stocks can lose their footing. Four months ago, it was worth $100, and now, even at $40, it still isn’t cheap enough.
How Is Micron’s 2018 Looking?
For the next few quarters, it appears that the demand for memory, particularly NAND, will outstrip supply. Analysts probably aren’t overly optimistic in their 2018 numbers. Micron could really put up $6.13/share in earnings next year, which is pretty amazing, considering it exceeds Micron’s stock price from as recently as 2013.
But after that, look for the party to end. It’s worth remembering that Micron only makes up about 20% of the market and has only a minimal moat. Samsung, which controls close to 40% of the market, can still drive down prices at its discretion depending on what it does with supply. And there are plenty of other suppliers that can react by raising supply to benefit from the current pricing boom.
In Micron’s defense, they have created a partnership with tech giant Intel Corporation (NASDAQ:INTC) that has created next-gen 3D NAND and 3D XPoint technologies. This will give Micron some insulation from competition, but does little to defend against the fierce price wars that tend to hit the DRAM side of the business.
Making Sense Of The Recent Dilution
Micron recently announced that it will be selling new stock in order to raise funds. It will use the cash received to pay off debt. This move made shareholders furious. MU stock dropped 5% on the day the news was announced. Critics said this was a ridiculous idea and point to the estimated 20 cents a share dilution that will hit Micron’s earnings as a result.
And yes, it’s true. If you think Micron’s earnings are going to keep growing steadily, selling stock would be almost indefensible. Why pay down debt with new equity when you can pay it off with earnings? However, I’d suggest management has a better grip on its business’ dynamics than some of its shareholders. Management remembers the real existential threats that took their stock down to $5 in 2013 and back to $10 in 2016.
When you’re up against a behemoth like Samsung, it’s best to clean up your balance sheet when you get the chance. Micron stock is up more than 100% over the past year. If you’re going to issue new stock and use it to fortify the company’s future, now is the time to act.
Micron is going to have a solid 2018, by all accounts. Demand still outstrips supply in the memory space. Earnings are heading higher, and everything appears to be trending nicely.
However, Wall Street is a forward-looking animal. It doesn’t just care that earnings are up this quarter, it wants to see that things will keep trending higher. Once growth slows down and the top of the cycle looks near, shares will start to slide again. It’s hard to predict which quarter will flip the switch. Even Einhorn got this second-level math on Micron wrong last time around. But management is giving us a big signal by issuing new stock now. MU stock is fully valued, and it’s not a bad time to take some chips off the table.
At the time of this writing, the author owned INTC stock. He had no positions in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.
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