Chip maker Micron Technology, Inc. (NASDAQ:MU) has seen its stock price rise nearly 200% since the start of 2016, as the company has found itself in the sweet spot of robust demand and constrained supply. But MU stock has just bounced around the $40 level for most of October.
Is this sideways trading simply a pause in a big rally or an indication that $40 is the mountaintop for MU stock?
I think it’s the former. The current dynamics of robust DRAM demand fueled by smartphones and data centers and constrained supply due to limited suppliers and heightened product complexity will continue to boost profit margins for Micron into the foreseeable future. Some day, supply will inflect dramatically upward or demand will inflect dramatically downward, and that will kill MU stock.
But that day is not today. Here’s why.
Bulls just received some big public support from hedge fund titan, David Einhorn.
The hedge fund manager recently disclosed that his Greenlight Capital fund made three new investments in the third quarter of 2017. One of those investments was MU stock.
It’s important to note here that Einhorn isn’t the type of investor who jumps on the momentum train. He is a value guy who often places bets against momentum. He is (in)famous for shorting Amazon.com, Inc. (NASDAQ:AMZN) and Tesla Inc (NASDAQ:TSLA).
It’s rather bullish, then, to see such a value-oriented investor who doesn’t like strong momentum names get on board with MU stock, which is up 200% in less than two years and is in the middle of what many consider a bubble.
Einhorn doesn’t buy the bubble talk. He thinks that because DRAM is starting to reach its lower limit in terms of size, pricing has stopped falling and will remain stable into the foreseeable future. Meanwhile, demand is ramping up thanks to data centers and smartphones. Diversified demand streams shield MU from harsh cyclical pullbacks in demand.
Plus, Einhorn likes the fact that Micron stock trades at just five times this year’s earnings estimate.
Overall, it’s bullish to see one of Wall Street’s most-followed value-oriented hedge fund managers bite into Micron at a time when bears are screaming “bubble.”
I continue to believe Micron will trend toward $50.
Fiscal 2018 earnings will represent peak earnings for MU. Supply will begin to ramp up in 2019 as new fabs start to hit the market. Thus, gradual volume expansion in 2019 will slowly eat into Micron’s profit margins. Demand will remain high, but lower profit margins will cause earnings to fall.
The fall won’t be big because volume expansion will likely be very gradual due to the limited number of suppliers and the heightened chip complexity. Overall, $5-plus earnings per share are likely here to stay into the foreseeable future. The Street is looking at fiscal 2020 earnings of $6 per share.
If earnings are at $6 by 2020, then Micron will have dramatically eased concerns about the risk of earnings suddenly and dramatically going negative. Consequently, MU stock should easily be awarded a 12- to 13-times multiple in 2020.
A 12.5-times multiple on $6 earnings implies a MU stock price target of about $75. Discount that back by a fairly aggressive 15% per year, and you get to a present value of about $49. The MU stock price is currently just under $42.
Micron stock will always be at risk of a competitor flooding the market with supply. But no signs point to that happening any time soon.
Micron will also always be at risk of a cyclical pause in demand. Again, no signs point to that happening any time soon.
So long as demand remains robust and supply remains constrained, MU stock will head higher.
As of this writing, Luke Lango was long MU and AMZN.