Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking two high-profile Wall Street picks and putting them under the microscope...
All of a sudden, it seems investors can't go wrong by buying stock in computer memory makers.
Three weeks ago, I wrote about Mizuho's upgrade of Western Digital (NASDAQ: WDC) stock, now that it seems it won't be as hard-hit by President Trump's trade war with China after all. Just earlier this week, the story was that Goldman Sachs upgraded shares of Western Digital rival Micron Technology (NASDAQ: MU) based on stabilizing demand for NAND flash memory, and hopes that DRAM demand will follow suit.
Today it seems another analyst likes 'em both!
Image source: Getty Images.
You get a price target hike! And you get a price target hike! Everybody gets a better price target!
According to StreetInsider.com, German megabanker Deutsche Bank has come out with improved price targets on Western Digital and Micron stocks -- up $10 apiece -- while maintaining buy ratings on both.
Let's take those one at a time.
A target hike for Western Digital
Calling the last three months "eventful" for the computer memory market -- with Western Digital shares in particular falling first 35% from their April highs, then surging more than 50% since mid-June -- Deutsche observes that "the power outage at Toshiba Memory Corp and the Huawei ban reprieve" appear to have turned things around for the company.
"[O]ptimism" is "increasing ... that the NAND industry will soon return to supply-demand balance," says the analyst, and while Q2 numbers could still be rough, it sees "upside" for Western Digital stock "given a better pricing environment and the resumption of shipments to Huawei."
Also helping Western Digital is a recovery in hard disk drive demand, which Deutsche says remains "on track despite some concerns of slowing enterprise spending." The analyst predicts Western Digital will gain market share there, helping the company earn perhaps $5.90 per share this year (presumably pro forma -- most analysts still predict the company to be unprofitable under generally accepted accounting principles this year), and leading Deutsche to raise its price target to 11 times that number, or $65.
And one for Micron, too
The story is similar for Micron, with Deutsche blaming the "Huawei ban and weaker server/smartphone demand" for early underperformance, and identifying the loosening of that ban, as well as Toshiba's power outage, as positives for the company's prospects.
More than these one-time events, though, the analyst argues that in general, "[M]emory suppliers are acting more rationally this cycle in terms of supply growth and pricing strategy," cutting output in the face of weakening demand, so as to restore supply-demand balance to the market and support prices -- rather than engaging in the kind of overproduction and price wars that can be so damaging to company profits.
In fact, in Deutsche's estimation, it's even possible that oversupply in the computer memory market could already be abating. The analyst predicts that the company's current fiscal Q4 2019 "will be the trough quarter for MU for this cycle." And to get ahead of the rebound, Deutsche is raising its price target on Micron stock to $55.
A plus for both companies
One final point in both companies' favor that needs to be addressed: While we're all well aware that there's an ongoing trade war between the U.S. and China, a second trade war has received less attention here in the U.S. This one's between Japan and South Korea -- and unlike the U.S.-China dispute, this one's a positive for memory makers.
As CNBC reports, Japan is concerned that South Korea is not exercising proper control of certain dual-use chemicals that it sells to Korea -- namely, "fluorinated polyimide, resist and hydrogen fluoride." Those materials have potential military applications, but are primarily used in the production of display screens and semiconductors.
That last bit is key, because citing these concerns, on July 4, Japan imposed export restrictions on these chemicals, requiring exporters to receive government permits for each shipment to Korea -- a 90-day process. Given that Japan produces 90% of global fluorinated polyimide and resists, and "about 70% of hydrogen fluoride," according to CNBC, these restrictions have the potential to seriously slow down semiconductor production by Japan's Korean rivals in the near term -- accelerating the drawdown of global NAND and DRAM inventories, and returning the market to supply-demand balance sooner than might otherwise have happened.
In other words: More good news for Western Digital and Micron.
The upshot for investors
Taken as a whole, all of the above factors "should disproportionately benefit MU versus its competitors," says Deutsche Bank. Granted, this doesn't prevent the analyst from recommending Western Digital as well as Micron. But if you ask me, Deutsche got it right the first time.
Consider that at 82 times trailing earnings today, Western Digital stock looks much more expensive than Micron at 5.1 times earnings. And while it's true that when valued on free cash flow, the disparity in valuations isn't quite so wide (Western Digital stock sells for 12.6 times FCF, Micron for 8.5 times, according to data from S&P Global Market Intelligence), Micron still looks a lot cheaper than Western Digital.
So if you're looking for a way to play the improving economics of memory making, I think Micron's probably your best bet.
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