At its heart, the argument over Micron Technology (NASDAQ:MU) is a battle over how to value a cyclical stock. It’s not an easy task. In a matter of quarters, the MU stock price went from being absurdly cheap — Micron stock traded at less than 4x earnings at points last year — to questionably expensive. Fiscal 2020 consensus EPS is just $2.53, implying a 17.5x forward P/E that’s not all that attractive in the context of the semiconductor sector.
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Even Wall Street can’t make up its mind. As Barron’s noted last week, analyst targets for the MU stock price range from $28 to $90. It’s a company that earned $12+ in adjusted EPS in fiscal 2018, posted a $1 per share loss as recently as FY12, and is expected to see a two-year, approximately 80% decline in EPS in FY20.
In terms of that argument, I wrote recently that I lean toward the bearish side. The recent rally in Micron stock looks ripe for profit-taking. Earnings may not be set to rebound any time soon. And I thought the Q3 report that sent the MU stock price skyrocketing was much weaker than headlines suggested.
Cyclical arguments aside, however, there’s a risk to MU shares that might not be fully appreciated at the moment. Micron is exposed to the U.S.-China trade war in a way that goes beyond the standard macro exposure of most semiconductor stocks. News on that front thus is likely to create volatility in Micron stock in the near term. And if the news winds up being as bad as it appears, it could send MU shares back toward recent lows.
The Huawei Problem for Micron Stock
The Trump Administration has made a clear target of Chinese telecom equipment manufacturer Huawei. The White House effectively blacklisted the company earlier this year, citing security concerns. President Donald Trump himself said this week that he wasn’t interested in allowing Huawei “to do business at all” with American companies, though the federal government soon after gave Huawei another 90-day extension.
Huawei’s tenuous status has been an issue for tech stocks, and particularly semiconductor stocks, for some time. Companies like Broadcom (NASDAQ:AVGO), Qorvo (NASDAQ:QRVO), and Intel (NASDAQ:INTC) all have seen revenue hits from ceasing or moderating sales to the networking giant. Micron’s rival Western Digital (NASDAQ:WDC) announced in June that it had stopped doing business with the Chinese company altogether.
For Micron, Huawei is a key customer. Per its 10-Q, 13% of revenue for the first three quarters of fiscal 2019 came from Huawei. And that’s with lower-than-expected revenue so far this year to begin with. On its Q3 conference call, the company cited a $200 million impact to revenue in the quarter. Q4 guidance — which was disappointing relative to expectations — also took a hit. And the company wrote down $40 million in Huawei-related inventory.
Lower Earnings Mean a Lower MU Stock Price
The problem for Micron is that 13% of revenue doesn’t necessarily mean 13% of profits. One only need look at YTD results to see that lower sales have a huge impact on earnings.
Through the first three quarters, revenue is down over 15%. Adjusted EPS has declined 32% with a lower share count.
Admittedly, lower DRAM and NAND memory pricing is a big factor. But losing 13% of revenue off roughly similar expense bases in R&D and G&A tends to depress margins and lead to amplified reductions in profit.
In other words, this is a big risk for Micron stock.
How Does This Play Out?
To be fair, a permanent Huawei blacklist doesn’t necessarily mean Micron’s revenue will fall by 13%. As CEO Sanjay Malhotra noted on the Q3 call, Micron supplies Huawei rivals as well (presumably including Nokia (NYSE:NOK) and Ericsson (NASDAQ:ERIC). Those rivals would take market share ceded by Huawei — and add to their purchases of memory from Micron.
But it’s still unclear that European countries, in particular, are going to follow the U.S. lead in banning the Chinese equipment maker. There will be some erosion if the U.S. moves forward in preventing its companies from selling to that company.
It’s also possible that, at some point, the ban will be lifted. The administration could be using Huawei as a bargaining chip. A broader trade war deal could include accommodation from Huawei, and any sort of resolution likely would move chip stocks, including Micron stock, higher.
But such a resolution seems a long way off at this point. In the meantime, Micron earnings are likely to decline, and the MU stock price may well follow suit. Between cyclical risk and political risk, there are plenty of reasons to stay on the sidelines here. Even bulls might want to show some patience and see if geopolitical factors don’t present a better entry point.
As of this writing, Vince Martin has no positions in any securities mentioned.
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