Early last week, I put out a piece on InvestorPlace saying buy Micron Technology, Inc. (NASDAQ:MU) stock ahead of what I thought was going to be a blowout beat-and-raise quarter.
All signs pointed to go. The Street was getting bullish as analysts came out in swarms recommending MU stock before the report. Supply constraints in the DRAM and NAND markets were starting to show signs of staying into the foreseeable future. The demand outlook was equally as rosy. Micron came out on Tuesday and delivered that blowout beat-and-raise quarter. Revenue and earnings for the fourth quarter smashed expectations, while the first quarter guide also smashed consensus estimates. The broad takeaway was that these favorable market conditions for MU (tight constraint, big demand) will continue for longer than the bears expected.
So investors are letting the good times roll. Since the report, MU stock is up almost 15%.
I think there is more upside in this name. Granted, fiscal 2018 marks peak earnings, but demand is so strong that even increased supply after fiscal 2018 won’t dampen earnings that much. A conservative multiple on down-the-road profits indicates that this stock could have nearly doubling potential in roughly 3 years.
Market Conditions Remain Favorable for MU
The big reason MU stock is in rally mode is because the strong quarter and even stronger guide imply that the current favorable supply-demand dynamics that are boosting margins and profits are here to stay.
For now.
Bears had expected increased capacity in the DRAM and NAND markets to start weighing on profits as early as the first half of fiscal 2018. After all, that is what happens in the cyclical semiconductor industry. When supply is low, margins are high and profits are big. Suppliers take those profits and invest in increasing capacity to gain market share. This increased capacity takes about two years to fully roll out, at which point the market gets flooded with supply. Margins drop and profits erode.
That is why stocks like MU are considered cyclical.
But this time looks a little different.
Granted, capacity is increasing, but not to any great extent that threatens positive profit margins at Micron. Part of this is that there aren’t many players in the DRAM and NAND markets anymore, so the limited amount of players ensures that supply will almost always remain somewhat tight from now on. The other part is that demand is so big (think cloud computing) that supply is going to have to increase a whole bunch to catch up to demand.
That just isn’t happening now. See Micron’s first quarter guide. It calls for nearly 60% revenue growth and huge gross margin expansion.
Bottom Line on MU Stock
At the end of the day, it always come back to the numbers.
So here’s what is happening at Micron. Fiscal 2018 is a peak earnings year because capacity hasn’t started rolling out and demand is still big. Demand will remain big into the foreseeable future, but starting in 2019, increased capacity will weigh on profit margins. Earnings will consequently fall.
As stated earlier, though, this earnings degradation won’t be terribly dramatic. In fact, the Street is modeling for earnings per share of about $4.70 in fiscal 2020. That seems fair to me because it is basically where earnings are today, before the huge demand ramp and subsequent supply increases, which should offset one another from a profit dollars standpoint.
A conservative 15-times trailing multiple on that $4.70 EPS estimate implies a 3-year price target of about $70. Discount that back by 15% per year, and you get to a present value of about $46.
MU stock currently trades just under $40.
So I think there is more upside in this name. Best thing to do right now? Stay the course.
As of this writing, Luke Lango was long MU.
