Micron Technology, Inc. (NASDAQ:MU) shareholders are feeling much better these days. Following a couple months of declines, Micron has rebounded by more than 10% over the past few days. And for all of 2017, MU stock is sitting on gains of nearly 40%.
But don’t even think about taking profits yet.
The Micron Selloff That Wasn’t
Micron’s shares fell roughly 17% in the weeks following its better-than-expected fiscal third-quarter earnings report, but the memory chip company has since gained the majority of that back. And the winners are the investors who ignored the noise and took the selloff as a chance to lower their cost bases.
Back in February when I first recommended MU stock — it traded at around $23 per share then — I told you this was one of the best turnaround stories on the market. The same bullish arguments I pointed out then, when I suggested the stock would reach $30 (it did), still are applicable today, maybe even more now than then.
MU stock is now priced more attractively at just 6 times fiscal 2017 estimates of $4.71 per share, against a forward price-to-earnings ratio of 19 for the S&P 500. And based on fiscal 2018 estimates of $6.05 per share, the forward P/E drops to five.
Essentially, the market assumes little-to-no growth for the company. This, even though Micron continues to demonstrate that it not only benefits from improved pricing in the DRAM and NAND memory chip market, but it’s also delivering strong profit margins. That’s even with intense competition from Samsung Electronics (OTCMKTS:SSNLF), Toshiba (OTCMKTS:TOSBF) and Western Digital Corp (NASDAQ:WDC).
From my vantage point, there’s still a strong case to be made that Micron stock can easily reach $40 by year’s end, delivering 33% returns.
It’s All About DRAM Pricing
The price of DRAM (dynamic random access memory) — flash memory for electronic devices such as tablets and MP3 players — continues to steer the Micron story, which is understandable. The fact that DRAM accounts for 64% of Micron’s revenue and about 70% of its gross profits makes investors gun-shy about betting too much on Micron, thus the below-average forward P/E.
The fear? Any slight change in the DRAM industry, resulting in oversupply, can negatively impact Micron’s pricing power and that of its competitors.
But the probability of that happening is highly unlikely, based on Micron’s guidance. Not only did MU top expectations for profits and sales in fiscal Q3, but the Idaho-based company also issued fourth-quarter gross margin guidance of 47% to 51%, implying expansion of 100 basis points sequentially at the midpoint. This suggests management expects the DRAM market to remain strong in the second half off the year.
What’s more, the company guided for fourth-quarter revenue of $5.7 billion to $6.1 billion (up 83% at the midpoint), while adjusted EPS of $1.73 to $1.87 is higher than the consensus of $5.62 billion and $1.58.
Micron’s confidence was supported by a recent Digitimes report, citing DRAMeXchange, which says DRAM contract prices would remain strong through 2017. The research firm noted that average selling prices for DRAM rose 40% sequentially, reaching $27 in the second quarter.
In addition to holidays causing higher DRAM demand, DRAMeXchange — while citing a two-week manufacturing halt at a Micron plant in July — noted that this year may see a tighter effect due to lower supply.
This all bodes well for Micron.
Micron Continues to Execute
Micron is coming off a strong third quarter during which revenue of $5.57 billion surged 92% year-over-year, while adjusted EPS of $1.62 skyrocketed from negative 3 cents a year ago. Both measures easily crushed consensus estimates of $5.41 billion and $1.52, respectively.
The bottom-line beat was driven by adjusted gross margin of 48%, which arrived at the high end of a 44% to 48% guidance range and up sharply from the second quarter’s 38.5% and the year-ago period’s 18.1%.
Micron, which has posted consecutive quarterly earnings beats, continues to benefit from a revived demand for its DRAM and NAND memory chips. And with increased probability that Micron can achieve higher gross margins, combined with favorable DRAM pricing through the end of 2017, it would be a mistake to part with this winner now.
Bottom Line for MU Stock
If Micron shares were priced on part with the rest of the market, shares would trade around $110, not $30.
This makes Micron — the leader in the memory chip category — an obvious choice for investors who are looking for an investment that can outperform the market in the next 12 to 18 months.
As of this writing, Richard Saintvilus did not hold a position in any of the aforementioned securities.