The downgrade of Micron Technology, Inc. (NASDAQ:MU) by Goldman Sachs is not looking very good now. It’s an unusual call, considering MU stock trades at a steeply discounted forward price-earnings ratio of 5.6. Not to mention Micron’s profit margins have surged due to a NAND shortage and the industry is showing no signs of the limited supplying moderating.
And as newer and faster computer parts from Advanced Micro Devices, Inc. (NASDAQ:AMD) and Intel Corporation (NASDAQ:INTC) come to market, demand for DDR4 will go up with it.
In the storage space, solid state drive demand will increase as consumers and businesses opt for its inclusion over mechanical hard disks. AI appliances also need fast storage and plenty of memory.
The increased demand, I believe, is enough to push Micron to $35 per share, roughly a 21% increase from today’s perch.
Micron’s Strong Quarterly Results
In the second quarter, Micron reported revenue soaring 58.7% year-over-year to $4.65 billion. Gross margin stood at a healthy 38.5%, almost doubling last year’s level of 20.4%. For the current (third) quarter, the company forecast revenue of $5.2 billion to $5.6 billion, easily surpassing the consensus estimate of $4.7 billion.
The company’s cost-cutting measures are adding to results. MU’s transition in manufacturing at the 20nm DRAM capability is benefiting the company, as the market’s favorable conditions are helping selling prices for DRAM. Prices rose 21% from the last quarter and will likely continue. For what it’s worth, no memory supplier has plans to lift output high enough to put a lid on prices.
Development of 3D XPoint
Looking ahead, Micron’s developments in 3D XPoint will solidify the company’s moat in memory technology. Neither Hynix nor Samsung Electronics (OTCMKTS:SSNLF) have an answer to Xpoint.
When it is released, expect profit margins getting a strong lift. Xpoint is not the only new market for the company. IoT markets are getting bigger and Micron’s components are at the center of it.
Valuations
Since Micron has clear profit growth ahead, assume annual revenue growth of between 10% to 15% for the next five years:
| Fiscal Years Ending | 16-Aug | 17-Aug | 18-Aug | 19-Aug | 20-Aug | 21-Aug |
| Revenue | 12,399 | 14,259 | 15,685 | 17,253 | 18,979 | 19,927 |
| % Growth | -23.40% | 15.00% | 10.00% | 10.00% | 10.00% | 5.00% |
| Ebitda | 3,274 | 4,705 | 3,137 | 4,313 | 5,694 | 5,978 |
| % of Revenue | 26.40% | 33.00% | 20.00% | 25.00% | 30.00% | 30.00% |
Source: finbox.io (click here to input your own assumptions)
Apply a high discount rate of between 12.5% to 13.5% to factor the risks of chip prices and competition from other suppliers:
| Low | Mid | High | |
| Selected Discount Rate | 13.50% | 13.00% | 12.50% |
| Implied Fair Value | $30.69 | $34.64 | $38.73 |
| Implied Upside / (Downside) | 6.50% | 20.20% | 34.40% |
Source: finbox.io (click here to input your own assumptions)
This implies MU stock is worth around $35 a share.
Bottom Line on MU Stock
Micron’s undervaluation will not last forever. If it earns $5 a share at a $35 share price, MU stock will trade at just seven times earnings.
If history repeats itself, chances are good Micron will report revenue that beats even the most optimistic consensus estimates. If that happens, Micron might even trade above my target price.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.
