by Tom Taulli | January 8, 2014 10:55 am
About a year ago, shares of Micron Technology (MU) were trading at a dismal $5.50. But it turned out to be a huge opportunity for savvy investors, as the stock has since surged to $24.
It certainly helps that the company — which is the largest U.S. manufacturer of DRAM (dynamic random access memory) chips — keeps announcing strong earnings, with the latest one coming out yesterday. For the fiscal first quarter, MU revenues more than doubled to $4.04 billion, while profits came to $358 million, or 30 cents per share.
Allowing for one-time items, adjusted earnings came to 77 cents per share, beating the Street’s estimates of $3.72 billion in revenues and profits of 44 cents per share. A big key to the improvement was the boost from the acquisition of Elpida Memory.
But has the stock become a bit too pricey? After all, MU stock has a long history of disappointing investors. Then again, perhaps the company is on the verge of a nice long-term run.
So, should you buy MU stock? Let’s take a look at the pros and cons:
Industry changes: For the past three decades, the competitive environment has been brutal for the DRAM market. For example, back in the 1980s, Japan flooded the market with chips. Then came waves from Korea and, eventually, Taiwan. The result has always been major drops in pricing, which cut into the margins of MU. But the market looks much different nowadays. There are no signs of any new unleashing of capacity. Keep in mind that, over the last few years, the number of DRAM suppliers fell from seven to three. In other words, there’s not much pressure on pricing.
Backing: David Einhorn, who is one of the world’s top hedge fund managers, called MU stock his “new best idea” (back in November). To this end, he took a stake of 23.02 million shares in the company — or 2% of the outstanding stock. Einhorn is known for his in-depth research and standout returns. He thinks that MU stock is at an inflection point, especially given the better controls over supply in the industry. In fact, he pegs earnings per share at $3.50 for this year and $4.00 for 2015. If so, the forward multiple is currently only at 7X.
Diversification: MU has taken major steps to move beyond the DRAM business, investing in categories like NAND, SSD and NOR technologies. All these are critical for fast-growing markets like cloud computing and mobile. MU also has the advantage of its massive scale of manufacturing, with operations in the U.S., China, Israel, Italy, Japan, Malaysia, Singapore and the Philippines. Besides, it is unlikely that there will be any new chip facilities built over the next few years. MU also has an extensive portfolio of patents, which has helped to protect its innovations.
Commodity business and PCs: Even though the DRAM industry has only three players, that doesn’t prevent price wars. True, the industry has been fairly disciplined. But if there is any weakness, the temptation may be strong to pump up production to grab more revenues. In fact, if there is a economic downturn — even a moderate one — the impact would be severe for a company like MU. At the same time, the PC segment is still a key part of the company’s business. The PC market is in the midst of a secular decline as businesses and consumers move towards tablets and other mobile devices.
Competition: By entering different markets, MU faces a new crop of fierce rivals like Samsung (SSNLF), SanDisk (SNKD), SK Hynix, Spansion (CODE) and Toshiba. Some of these companies have diverse revenues streams and thus can reduce prices on commodity chips to gain more market share — and make up the shortfall.
Acquisition risk: This is always an issue, especially in the tech sector where it can be tough to integrate different cultures and systems. There are also risks of over optimism with cost cuts and revenue synergies. In some cases, the customer base can even be eroded. While MU’s M&A track record has been good, it only takes one bad deal to do lots of damage.
Despite the risks, MU stock still looks attractive. The company has major barriers to entry, such as a massive manufacturing and distribution footprint. There is also a strong patent portfolio and continued investments in R&D.
More importantly, the supply-demand situation in the DRAM markets looks stable. And with the renewed growth in the US economy, as well as the ramp with smartphones and tablets, the future looks bright. The recent MU earnings report is yet another sign that the company is on a nice rebound.
So, should you buy MU stock? Yes, in light of these factors above and the reasonable valuation, the pros outweigh the cons on the stock for now.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
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