Micron Technology, Inc. (NASDAQ:MU) reports fourth quarter earnings on Sept. 26, and I think MU stock looks pretty tasty ahead of that report.
Let’s recall the broad narrative surrounding MU. Micron stock has rallied more than 150% since the start of 2016, versus a 25% gain for the S&P 500 Index. The huge increase has been driven by the convergence of multiple demand tailwinds and zero supply headwinds.
Demand is ramping in a big way. Cloud data centers are growing at an unprecedented pace. Mobile workload demand continues to go up and up. The Internet of Things (IoT) is giving birth to an entirely new growth area for performance, data collection and data storage. Virtual and augmented reality are reinvigorating the video game world.
Meanwhile, supply is constricted in a pretty big way. To begin with, as Barron’s pointed out, there aren’t many players; really only three on the DRAM side of things and five on the flash side. As well, the in-demand chips are the more-complex ones, so suppliers are now investing in technology rather than just building out capacity.
The combination of fewer producers and lower capacity leads to tight supply. Tight supply plus big demand equals big gains in profitability.
This positive growth narrative will continue when Micron reports what I think will be a beat-and-raise quarter on Tuesday. All signs point to this current supercharged DRAM up-cycle continuing into 2018. Meanwhile, multi-year demand ramp should offset concurrent supply ramp, so the chip pricing environment should remain favorable over the next several years.
Those dynamics imply that this era of $5-plus earnings per share is here to stay. If that elevated earnings level is sustainable, why should MU stock continue to trade at just 5.5x 2018 earnings estimates?
It shouldn’t.
Wall Street Loves Micron Stock
I’m not alone in this thinking. In fact, a swarm of Wall Street analysts have recently come out with bullish notes on Micron stock.
Evercore ISI recently raised its price target on Micron stock by $10 to $50 (implying almost 40% upside). The boost is fueled by expectations for this current DRAM up-cycle to continue in 2018. According to Evercore analyst C.J. Muse, demand is ramping and supplies will remain tight due to rising complexity.
Goldman Sachs recently upgraded Micron stock to a “Buy” with a $40 price target (10%-plus upside). Like Evercore, Goldman believes the current DRAM up-cycle will continue. Goldman believes DRAM prices should continue to increase in 2018 while NAND prices should be flattish to slightly up.
Cleveland Research also thinks that the current DRAM cycle will continue in 2018. Their neighbors at KeyBanc Capital Markets expect MU to deliver a beat-and-raise report on Tuesday. Deutsche Bank is also bullish on Micron stock, saying that “disciplined capex by memory suppliers will prolong this upcycle”.
JPMorgan thinks that strong iPhone 8 and iPhone X demand will be a huge tailwind for Micron stock. The thesis is pretty straightforward: Super-charged iPhone demand will create super-charged DRAM demand. That will help keep DRAM supply tight for most of 2018.
All in all, its pretty clear to see that the Micron bulls have come out in full-force recently.
With good reason.
Demand for DRAM
Demand isn’t going anywhere anytime soon. The iPhone 8 and iPhone X will provide huge demand tailwinds in 2018, but even after that, mobile workload demands will only continue to go up. IoT is really just scratching the surface of its potential as a global market.
Hyperscale data centers are only getting bigger and harvesting more complex data. Plus, the virtual and augmented reality catalysts haven’t really even hit the market yet.
That’s why Micron believes DRAM demand will grow anywhere from 20% to 25% annually into 2020. That seems very reasonable given the demand boom. Meanwhile, Micron believes capacity will grow by 20% annually in that time frame.
That capacity increase also seems reasonable, because it’s what DRAMeXchange pegs as the supply growth rate for both this year and next year.
Bottom Line on MU Stock
MU stock trades at a depressed forward earnings multiple because the market is worried the good times won’t last. At some point, supply will outstrip demand, and Micron’s profit margins will erode.
That will happen at some point, but not now or anytime soon. The reality is that the general trend of under-supply in the all-important DRAM market will persist into the foreseeable future.
Micron’s Q4 report should affirm this and that should send Micron stock materially higher.
As of this writing, Luke Lango was long MU.
