2015 wasn’t a very good year for memory chip makers, as three giants, Micron Technology, Inc. (NASDAQ:MU), SK Hynix and Samsung (OTCMKTS:SSNLF) battled each other over price. Micron stock fell 60% in 2015.
At the beginning of 2016, Micron stock was trading at around $14 a share. Rising memory chip prices in the second half of 2016 boosted MU, helping Micron take back some lost ground.
Now, Micron stock is up almost 60% year-to-date in 2016. MU stock seems to be facing some tailwinds, but risks remain. China is a wild card, as it wishes to build up its domestic semiconductor industry and is going on a buying spree. Both SK and Micron received offers from China in 2015.
But after soaring this year, does Micron stock still have any upside? Let’s look at the pros and cons.
Micron Stock Pros
Improving Competitive Environment: As McKinsey notes, from 1996 to 2012 fierce competition prevented memory chip makers from seeing profits. This began reversing around 2012, with the industry consolidating as numerous players exited in the midst of the global recession. Now, only a handful of players remain, with Samsung, SK Hynix and Micron accounting for 90% of market share in 2014.
This reversed in 2015, when memory chip prices fell again, lowering the stock prices for Micron and its competitors. Now, oversupply seems to be abating again. Amidst an industry downturn, Samsung and SK Hynix cut back on DRAM investments, switching focus to NAND. Now, rising memory prices are boosting Micron’s revenues and earnings.
Even if Samsung and SK Hynix were to reverse their moves and ramp up DRAM production, the impact won’t be felt overnight. This means less pricing pressure on Micron for the time being.
High Barriers to Entry in Memory Chip Production: High barriers to entry in memory chip production reduce the threat of new entrants taking market share and profits away from Micron. As McKinsey notes, entry into the memory chip business requires both large scale and strong technical capabilities.
Ability to compete in a commodity industry such as memory chips depends mostly on production costs, and larger scale reduces costs. The cost of building state-of-the-art fabs increased dramatically over the past few years, from $1.7 billion in 2001 to $10 billion now. Investopedia notes that these barriers to entry may no longer hold, since fabless manufacturing allows chip makers focus on design and outsource the production to foundries.
But the second barrier to entry remains. Entering the memory chip market is difficult since it requires a great deal of expertise, technical know-how and IP. The shrink in the size of chips makes this more complex than before. Only a handful of companies have these capabilities, and they are difficult to acquire.
Inotera Acquisition: Micron stands to reap benefits from its acquisition of Inotera Memories of Taiwan, having bought out the remaining 67% interest for $4 billion. Earlier in December, Micron CEO Mark Durcan outlined the advantages Micron will gain by acquiring Inotera:
“We are excited to finalize the Inotera acquisition which will generate significant financial and strategic benefits for the company. We expect immediate accretion to DRAM gross margins, earnings per share and free cash flow along with enhanced operational efficiency as we align Inotera with our global manufacturing operations.”
Micron should also see cost savings as a result of the purchase, as Inotera earned $600 million from sales to Micron in fiscal 2015. Lower costs will improve Micron’s competitive position.
Also, Micron will actually reduce its overall leverage by buying Inotera. Inotera’s debt-to-equity ratio is lower than Micron’s, at 12% vs. 82%, lowering the debt ratio of the combined company to 79%. This will improve Micron’s financial position and perhaps help Micron get a better credit rating.
MU Stock Cons
Despite Improvements, The Memory Chip Industry Remains Competitive: Fortune called the memory chip industry “a sometimes brutal market subject to oversupply and commodity competition.” As Micron notes in its 10-K:
“We face intense competition in the semiconductor memory market from a number of companies, including Intel; Samsung Electronics Co., Ltd.; SK Hynix Inc.; Toshiba Corporation; and Western Digital Corporation. Some of our competitors are large corporations or conglomerates that may have greater resources to invest in technology, capitalize on growth opportunities, and withstand downturns in the semiconductor markets in which we compete.”
Micron and SK Hynix compete against Samsung, a diversified conglomerate making other sorts of electronics. This makes Samsung a formidable competitor, as it is less vulnerable to downturns. Samsung may be able to put money into R&D or fight for market share when Micron and SK Hynix face problems.
The Memory Chips Industry Is Very Cyclical: The memory chip industry is not only competitive but also very cyclical. A downturn could send chipmakers into the red and potentially put some out of business. The risk of buying high is greater with cyclical stocks like Micron, but so is the reward. Ideally, one would have already bought MU stock when it bottomed out this spring at less than $10 a share.
Micron’s vulnerability may be greater since it is dependent on memory and not diversified like Samsung or Toshiba Corp (USA) (OTCMKTS:TOSYY).
A rise in interest rates could pose problems as well, since Micron has taken on debt to fuel its acquisitions. Rising interest rates might depress capex, and cause businesses to reduce their spending on new hardware, meaning less revenue for Micron. However, these concerns may be overblown, since technology stocks such as semiconductors tend to do well as rates rise.
China Risks: Micron depends a great deal on the Chinese market, making it very vulnerable to developments there. In 2016, Micron sold $5.3 billion in China and $12.4 billion worldwide, so China accounts for 42% of Micron’s revenue.
Last year, McKinsey detailed China’s ambitious plans to develop a domestic semiconductor industry. The Chinese government wants to invest $100 billion to $150 billion to develop Chinese chipmakers. China’s Tsinghua Unigroup tried to buy Micron last year, but failed.
Barriers to entry and long payback periods will not deter the Chinese government, which sees China’s dependence on imported foreign technology as a strategic liability. The government wants China to produce 70% of the chips it uses by 2025. Bain & Company, however, doubts that these plans will succeed.
Micron’s CEO Mark Durcan worries that Chinese chipmakers might flood the world market and wipe out competitors, just as they did with solar panels a few years ago.
Buy or Sell Micron Stock?
Micron may have some room to grow before the next downturn in memory chips. And Micron isn’t overvalued, and may be trading at a discount relative to peers. This summer, there was talk of Micron being acquired by Intel Corporation (NASDAQ:INTC) or China. Micron works with Intel, and buying Micron would help Intel pivot into non-volatile memory. Buying Micron makes sense if one thinks talk of a merger could resurface at some point.
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.
