Back in May, I wrote about whether the rally in Micron Technology, Inc. (NASDAQ:MU) — which is a developer of DRAM and NAND flash memory chips — was sustainable. While I noted the risks, I still thought there was quite a bit of upside left for Micron stock. Since then, things have panned out quite nicely: MU stock has gone from $12.72 to $20.61.
But as good as that may be, should investors be cautious with Micron stock?
If anything, I think the bull case is intact. Although, it is probably not reasonable to assume that there will be another massive move. There are still some potential headwinds, such as the uncertainty regarding Donald Trump’s policies for Asia (MU derives quite a bit of business in China).
So what are some of the drivers to keep in mind for Micron stock? Let’s take a look at three that stand out.
Three Reasons Micron Stock Is a Buy
Favorable DRAM Trends
For the most part, investing in MU stock is about cyclical trends, which may last a couple years. The good news is that the company appears to be in the early stages of a nice upswing in the DRAM business.
One of the critical factors is the consolidation of the industry, which has led to more rational supply decisions. Keep in mind that, since 2014, there has only been one major chip fab that has come onto the market.
At the same time, there are some important demand drivers. Let’s face it, memory chips are critical for such categories as mobile devices, embedded systems and even cloud computing. Oh, and the PC market has been perking up lately.
As InvestorPlace.com’s James Brumley noted recently: “[Micron was] rocked by a perfect storm just two years ago, but the next two years are going to look very different. The supply glut problem is in the past, the upgrade cycle is spinning again and memory prices are in excess of production costs. Micron stock is a good looking dark horse idea headed into 2017.”
Aggressive M&A and Innovation
Micron is one of the pioneers of the chip business, with the company’s roots going back to the late 1970s. No doubt, not many tech operators have remained competitive for such a long time. But then again, MU has the corporate DNA of pushing the boundaries of innovation as well as being bold with acquisitions.
For example, the company has been smart to invest in next-generation technologies like 3D NAND chips. But MU has also been adept at diversifying its business. Consider that only about 20% of the DRAM business comes from PCs, with the rest in areas like mobile (25%), servers (in the high teens) and specialty systems (low 30%).
In terms of mergers and acquisitions, Micron has been fairly disciplined. A prime example is the $4 billion purchase of Inotera. By doing this, MU eliminated a fierce rival and essentially got ownership of the DRAM production and a rich trove of intellectual property. The deal also came at a pretty cheap 2.2X EBITDA.
During the first week of December, MU CEO Mark Durcan gave a bullish comment on the deal: “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 does have a heavy debt load, which is currently at $11.6 billion (this includes the amount from the Inotera deal). Yet the fact is that the company continues to generate substantial cash flows. During the latest quarter, the operating cash flows came to $896 million. In all, there is about $4.8 billion in the bank.
It certainly helps that MU is diligent about collections and efficiency. There is also a plan in place to realize $80 million in quarterly cost savings.
Bottom Line on MU Stock
Finally, the valuation on Micron stock remains fairly cheap, with the forward price-to-earnings ratio multiple at 9.7X. By comparison, Intel Corporation (NASDAQ:INTC) is at 13X, Texas Instruments Incorporated (NASDAQ:TXN) sports a multiple at 21.5X and Qualcomm, Inc. (NASDAQ:QCOM) trades at 13X.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is a registered investment adviser representative (you can visit his site to learn more about his financial planning services). He is also the author of various books on investing like All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.