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Micron Technology, Inc. (NASDAQ:MU) has seen its shares rise rapidly over the last two months on the back of a recovery from an unjustified share price decline last fall. With macro tailwinds, Micron gaining strength in areas such as data centers, and thanks to solid cash flows and an inexpensive valuation, Micron has additional upside potential over the current year. This is despite shares having rallied by more than 40% from their 52-week low already.
Micron is one of the largest DRAM producers in the world. Thanks to a strong demand picture — DRAM is needed for all kinds of technologies, including big data, computing Information technology, smartphones, autonomous driving, and so on — Micron has been able to generate compelling revenues in the recent past:
Since early 2020, Micron’s trailing twelve months revenue has risen constantly, which was possible thanks to an upward trend in the company’s revenue on a quarter-to-quarter basis. That stopped during the most recent quarter when MU’s revenue declined on a sequential basis. But even at the current pace, Micron Technology’s ttm revenue could continue to rise for a while. A $7.7 billion quarterly revenue number equates to around $31 billion in yearly revenue, which is higher than the current ttm number of a little below $30 billion. Revenue is generally impacted by two key factors, Micron’s sales volumes, and its ASP, or the price per unit that it is able to demand from customers. Sales volumes have historically been rising relatively consistently, as our modern way of living requires a steadily rising amount of memory power for communication, entertainment, commerce, etc.
However, pricing is not steadily improving, as there are times when the supply-demand situation is more in favor of memory producers such as Micron (resulting in high ASPs), and times when supply is growing faster than demand, which is when ASPs contract. This can result in revenue declines despite rising sales volumes. In the past, when the memory industry was more fragmented, those cycles were more pronounced. They have become less severe in the recent past thanks to consolidation in the industry. With the memory industry being an effective oligopoly, unreasonably large supply growth is not a major concern any longer, which is why Micron’s revenue and profit have become less cyclical over the last decade. Some cyclicality still exists, however. Micron has also been moving towards higher-value segments in the memory industry, such as high-bandwidth memory, where Micron is active with its HBM2E offering. Micron’s Authenta technology, which allows for some additional protection on a system-level basis in IoT devices and similar products, is another way for Micron to provide non-commodities, value-add products. In these less generic, less commoditized product categories, Micron can more easily demand fixed prices and lock in longer-term contracts, which lessens the cyclicality further.
This, combined with the aforementioned factors such as the oligopoly working better and the longer-term demand picture looking good, should allow Micron to become an even less cyclical company over the years. Less pronounced cyclicality has significant tailwinds, and should allow for more consistent shareholder returns and could also warrant a higher valuation (e.g. a higher earnings multiple).
Micron’s cash flow has been surging in recent quarters. Based on the close correlation with the company’s EBITDA, which is forecasted to rise massively this year and next year, investors can expect further growth in Micron’s cash generation. If Micron hits the analyst estimate for $22.5 billion in EBITDA next year (September 2022 to August 2023), the company could be generating $20+ billion in cash from operations in that year. Relative to a current market capitalization of around $100 billion that would be highly compelling. High cash flows would also allow for a further increase in Micron’s shareholder returns, either via more aggressive buybacks or via higher dividend payments (or both).
According to Micron Technology’s most recent 10-Q filing, the company had $9.6 billion in cash on its balance sheet at the end of November, partially offset by $7 billion in short- and long-term debt. In total, that makes for a net cash position of close to $3 billion, which gives Micron a very healthy balance sheet. It also provides for a lot of optionality when it comes to making acquisitions, increasing capital expenditures, or increasing shareholder returns.
In the current fiscal year, which ends in August, Micron will likely generate highly attractive profits. Even more importantly, current forecasts see Micron generate even higher profits in Fiscal 2023:
With Micron likely to earn about $9 this year, and $12 and $13 in the following two years, the company will be highly profitable for three years in a row. Compared to the cyclicality that Micron experienced in the past, that is a strong feat. This can be attributed to the factors mentioned above, such as a strong demand picture, a move into less cyclical product lines, etc. The ongoing global semiconductor shortage also is a tailwind, as it allows for strong pricing.
Micron’s shares have already risen by around 40% over the last couple of months since bottoming in fall 2021, but shares have more upside potential. Investors should keep an eye out for announcements by Micron and its peers when it comes to capital spending plans. If Micron and/or the other members in the memory oligopoly (Samsung (OTC:SSNNF) and SK Hynix) become too aggressive with capacity expansion plans, that could negatively impact the supply-demand picture. Lower average sales prices would hurt all members in this oligopoly, including the company that started it all by building out production capacity too aggressively. For all three players, it is important that capacity additions are in line with or below forecasted demand growth. Capacity addition plans by Micron and its peers are thus an important item to watch for Micron’s shareholders, as this will likely have an impact on MU’s profitability in the coming years, although with a time lag, as it takes a while for new fabs to come online.
Investors will also be highly interested in seeing where Micron will go when it comes to its shareholder return program. The company is currently paying out $0.10 per share per quarter in dividends, which makes for a yield of around half a percentage point. Thanks to a payout ratio of around 5%, Micron could easily ramp up its dividend spending considerably. Even if the company were to hike the payout by 300%, it would only have a dividend payout ratio of around 20%, which would still be quite conservative.
Due to a not very high valuation, it is likely that management will continue to favor buybacks as a form of returning cash to the company’s owners for now. That does make some sense, especially if one is positive about MU’s longer-term outlook, which seems to be the case for management. With Micron getting a new CFO (its CFO moved on to become CFO at Intel (NASDAQ:INTC)), there is some uncertainty around Micron’s future cash return policy. It is likely that investors will get more information on that subject in coming earnings calls and shareholder events.
Micron has risen sharply since bottoming in the $60s, but its shares are by no means expensive today. Based on forecasted earnings for the current year, Micron trades at 10.7x net profit, while the earnings multiple for the coming year stands at just 8x. It is thus not surprising that analysts are seeing solid price upside potential for Micron’s shares over the next year:
Based on a twelve-month price target of $108, Micron has about 15% upside potential according to Wall Street. I do believe that Micron should trade at 9x forward net profits or higher at the beginning of its fiscal 2023, i.e. in fall 2022. This gets us to a price target of $105, implying an upside potential of around 10% from the current level.
Micron is quite profitable today and will see its profits rise further going forward. Shares are not looking expensive today at all, being valued at just 8x next year’s net profits. Cash flows should improve, which opens up the possibility for more ambitious shareholder returns in the future, although we do not yet know what the company’s next CFO (not yet announced) aims for in that regard.
Micron has, I believe, a solid upside of 10%+ over the next year. At the same time, shares are not as outrageously cheap as they were last fall when they were trading at less than $70, thus the risk-reward picture has worsened to some degree.
We called Micron a Buy last fall, but since shares have returned 30% since then, we are somewhat less bullish today. Overall, I do believe that Micron is still a very solid investment, but waiting for a more opportune entry point could pay off, as MU is currently trading pretty close to the 52-week high.
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