Why Micron Technology Inc Stock Is A Good Buy For 2018

Continued deleveraging of the balance sheet will make Micron Technology Inc stock more attractive.

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Micron Technology Inc (NASDAQ:MU) stock has pulled back a bit in the last few weeks. The stock has been weighed down by investors’ concern about rising supply in memory chip market which could lead to a slowdown in Micron revenue growth. But the company put any slowdown fears to rest (at least for now) by delivering better than expected performance in the Q1 FY 2018 and providing a strong guidance for the next quarter ending February 2018. The stock was up 4% yesterday.

A closer look at Micron’s fundamentals.

First, let’s have a closer look at Micron’s performance. For the tenth consecutive quarter, Micron delivered a better than expected earnings. Adjusted EPS came in at $2.45, 25 cents higher than what analysts were expecting and 22 cents more than the higher end of the company’s Q1 guidance. This was 7.6x higher than the last year comparable quarter numbers. On the top line front, Boise, Idaho based company reported revenues of $6.8B (+71.3% Y/Y), $420 million higher than Wall Street estimates.

Moreover, the company was able to keep its costs in check, resulting in margin expansion, both on the yearly and sequential basis. Gross margin came in at 55%, 500 basis points higher than the last quarter and more than double the year-ago margins. Gross margin was also helped by improving product mix.  Operating expense saw a marginal rise, from $629 million in year ago quarter to $639 million resulting in operating margin expansion from 9% to 45%.

Micron continued to benefit from the memory tight demand-supply equation in the memory chip market which is driving prices higher. According to DRAMeXchange, the average spot price for DRAM in November was almost double the year ago price, while average NAND Flash spot prices were up 41% for the same period.

Improving balance sheet health.

Micron also continued to de-risk its balance sheet in the Q1 FY 18. The company has seen its long-term debt rise from $4.45 billion at the end of FY 2013 to $11.31 billion in the second quarter of 2017. Debt to equity ratio rose from 0.47 to 0.77 in the same period.

In the last one year, this rising financial leverage has magnified the returns for Micron’s equity holders. Return on invested capital (which includes both debt and equity) improved from around 1% in Q4 2016 to 20% in Q4 2017 while return on equity rose from negative 2.5% to 35% in the same time period (it was 40% in the Q1 FY 18).

However, financial leverage is a double-edged sword and could have an equally disastrous effect on the company’s equity returns and earnings in case of a cyclical downturn. And given that Micron continues to generate billions of dollars in free cash flows, the company has the ability to pay down its debt. Micron has been reducing its debt burden since the second quarter of FY 2017. In the previous quarter, the company paid off $2.25 billion by paying $2.42 billion in cash.

While the company was forced to recognize a non-operating loss of $190 million on this transaction, the continued deleveraging of the balance sheet will not only reduce interest payments but also reduce the inherent risk in the company making its stock more attractive. Moreover, buying back convertible debt will have an anti-dilutive effect on Micron’s earnings. Also, Micron’s effective tax rate is very low, the tax advantage of debt is marginal for the company.

Micron stock still has upside left.

Micron also gave a better than expected guidance. Contrary to analysts’ expectations, Micron expects sequential growth to continue in the next quarter. The company expects second-quarter revenues to come in between $6.8 to $7.2 billion. The lower end of this guidance is higher than the higher end of analysts expectations. Same is true with the bottom line. Gross margin will further expand to 56% in the next quarter, driven by higher prices and cost-cutting. The strong guidance has calmed the market fears of a slowdown to some extent.

In our previous post on Micron “This Time Is Different” we had argued that the company continues to remain a solid growth play and the stock is a good buy.  While Micron stock is up over 20% since then, we still believe that the stock has more upside, especially given the potential demand from cloud computing and autonomous driving segments.

Cloud computing and autonomous driving to be big sources of demand.

Increasing server memory content will be a big source of demand. On the SSD side, the company expects the flash attach rate in servers to grow from 2500 GB in 2017 to 8000GB by 2021. On the DRAM side, the average server capacity is expected to grow from 145 GB to 300 GB. DRAM bit shipments to both cloud and enterprise customers were up by more than 50% year-over-year in the first quarter.

Add to this, the demand from autonomous driving vehicles which is likely to see strong growth. “The rapid innovation in automotive technology towards autonomous driving continues to create significant demand for higher memory capacities and greater performance.” Micron CEO Sanjay Mehrotra said during the earnings call. Considering that autonomous vehicles will have to quickly make massive calculations they will require high-performance memory, an area where Micron has a strong presence. Micron is already shipping its fastest LPDDR4x memory, enabling system bandwidth speeds of up to 100 GB per second. All in all, Micron is likely to see continued growth in demand.

This is not to say that there are no hurdles for the company. A surge in capital spending by companies like Samsung coupled with a large number of government-backed fabs under construction in China could boost supply next year, driving prices downward. NAND prices already appeared to have peaked for now. Fortunately, NAND contribution to Micron’s overall revenue is low and has come down in recent quarters.

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