It’s been quite the roller-coaster ride for Micron Technology, Inc. (NASDAQ:MU) stock. Five years ago, MU stock traded just above $6. The company was toward the end of its fiscal 2012 (ending August), in which the company would lose more than $1 per share amidst a 45% decline in DRAM pricing. The “death of the PC” at the hands of the Apple Inc. (NASDAQ:AAPL) iPhone seemed set to take Micron — and Micron stock — down with it.
In July 2012, however, Micron agreed to acquire the bankrupt Elpida. The deal gave Micron cheap incremental manufacturing capacity.
A supply agreement with Apple, and rationalized production in the DRAM space. Micron swung to a profit in 2013, thanks to accounting adjustments from the acquisition — and Micron stock took off. From the beginning of 2013, MU stock gained nearly 500% in less than two years.
Rival Samsung Electronics (OTCMKTS:SSNLF) would ruin the party, however, as it ramped up supply to take market share, destroying pricing in the process. Micron sales fell 23% in fiscal 2016. Per-shared earnings dropped from $2.71 in 2015 to a loss of 27 cents in 2016. And a little over a year ago, MU stock dropped back to the single-digits — a 70%-plus decline in roughly 18 months.
That history still hangs over Micron stock. It’s why MU shares trade at six times FY18 consensus estimates. We’ve been here before with MU stock. The question is whether this time is different for Micron.
There are reasons to think it might be — or at least different enough that Micron stock could have more upside.
Will Pricing Again Tank Micron Stock?
Micron’s recent earnings strength has been driven in part from steadily increasing pricing. DRAM prices (DRAM accounts for 60%-plus of Micron sales) rose 5% quarter-over-quarter in Q1 and 21% in Q2. That pricing has created a huge boost for Micron gross margins. Fourth-quarter GAAP gross margin was 18%. In Q1, the figure hit 25%; and in Q2 it rose to 38.5% (non-GAAP), with Q3 guidance at 44%-48%.
The obvious concern is whether that pricing is sustainable. The problem with DRAM, in particular, is the level of commoditization across the industry. When gross margins peaked a few quarters back, Samsung ramped up its production, leading to pricing pressure across the industry. As a result, Micron’s gross profit margins in the first three quarters of FY16 declined almost 13 full points, falling from near 34% to under 21%.
Even MU stock bulls don’t expect sustainable long-term margins in the 40%-plus range. But there is reason to believe that a repeat of the disastrous FY16 may be avoided. Competitor Western Digital Corp (NASDAQ:WDC) doesn’t appear to be rocking the boat.
Former CEO Mark Durcan (who stepped down earlier this year) told Barron’s that he didn’t see new supply on the way. Equipment suppliers like Lam Research Corporation (NASDAQ:LRCX) continue to see long lead times. And with Samsung dealing with a bribery scandal, it may not have the desire or the ability to be as aggressive as it was the last time the cycle hit a top.
Certainly, Q3 guidance suggests continued favorable pricing, and it seems likely Q4 will be strong as well. That could cushion MU stock in the near term. Over the long haul, capacity will be increased, one reason Goldman Sachs downgraded Micron stock last month. But that doesn’t mean that FY16 results will repeat, or that MU stock will tumble as it did in 2015.
Micron Is a Better Company
It’s also worth pointing out that some of the recent strength is coming from Micron’s own efficiency efforts. Pricing is behind some of the explosive growth and gross profit improvement of late — but not all of it.
Micron also has cut costs, with the ability to reduce those costs by more than 20%, per Durcan on the company’s Q2 earnings call. Gross margins certainly would have increased otherwise, given gains in pricing. But it’s been the combination of pricing and efficiency that has led those margins to better than double in just a few quarters.
And while Micron’s efforts to diversify into higher-margin, less-commoditized products is years away, the company is far less reliant on PC sales, in particular, than it was just two years ago. In Q2, 16% of total revenue came from DRAM sales into PCs. While 9% of sales were in consumer NAND products. But the other three-quarters of revenue came from mobile, SSDs, servers and even graphic and automotive applications.
This isn’t the “same old” Micron. The lessening reliance on PC sales, in particular, means that it might be different this time for Micron stock.
Valuing MU Stock
I’ve admittedly been rather cautious on MU stock, but the strength of the Q2 beat and Q3 guidance seems likely to support the stock at least for the near term. Longer term, there are reasons to see a less-volatile trading range — even if results are going to move substantially with pricing.
The problem is what that means in terms of valuing Micron stock. A cyclical stock should see multiples compress at the top of the cycle. But MU stock already trades at under six times FY18 estimates, and maybe 7x FY17 results, assuming a reasonably in-line Q4. It’s difficult to see much more multiple compression — unless investors anticipate a potential return to little or no profitability come 2019 or 2020.
As long as pricing holds, MU stock should have more upside. And if the cycle turns, Micron stock can stay reasonably steady as long as investors believe the downturn won’t be as severe as the last one. At the moment, that seems possible. And that seems to imply another leg up for MU stock.
As of this writing, Vince Martin has no positions in any securities mentioned.