In the middle of November, I said $50 was a good level to watch for Micron Technology, Inc. (NASDAQ:MU). I felt that was the price at which fundamentals implied MU stock was fairly valued.
The stock ended up rallying to that $50 level by Nov. 24, and that was the time to sell. After trading just shy of $50, MU sharply reversed and has since fallen all the way back to $42 and change. In just a few days, it has wiped out all of its November gains.
The recent price action on Micron stock tells me two things: The stock can rally from this big sell-off back to near $50, and it isn’t going to 4-5x over the next two years like it has over the past two years.
The actionable takeaway? Buy MU stock on this dip, but don’t hold forever. Valuation matters.
MU Isn’t Headed for $100 Anytime Soon
Some bulls want to claim that the good times for Micron stock will keep rolling forever. That just isn’t how the semiconductor industry works.
The industry is inherently cyclical. While demand usually just goes up (with some exceptions), the market consistently cycles between eras of under-supply and over-supply. When supply is low, suppliers like MU have pricing power. Consequently, prices go up, margins explode higher and profits are huge.
Suppliers then 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 becomes over-supplied. Suppliers lose their pricing power. Prices go down, margins erode and profits are wiped out.
Don’t believe me? Look at the Micron stock chart. The stock is cyclical. It goes up big, then down big, then up big, mirroring the supply cycles. Because of this, MU stock simply heads largely sideways.
Thus, the stock isn’t heading towards $100 any time soon. This isn’t a stock you want to buy near a peak and hold forever. It is a stock you want ride so long as the music keeps playing, but sell before the music stops.
MU Can Head Back To $50
Although MU stock won’t double from here, the recent sell-off does plunge it into undervalued territory.
Right now, chip suppliers are benefiting from an era of unprecedented pricing power thanks to robust and growing demand creating an exceptionally under-supplied market.
The demand won’t go anywhere anytime soon (think datacenters and smartphones), but supply will inevitably bounce back as suppliers try to win over market share from one another during this Golden Era.
It certainly appears as though supply will start bouncing back next year. Samsung is reportedly shifting from a technology migration focus in 2017 to a capacity expansion focus in 2018 in order to preserve its dominant DRAM market share.
New product will flood into the market, causing the current limited supply situation to be less favorable into the foreseeable future. But demand will remain big. Demand from mobile, Internet-of-Things (IoT), AI, and data-center markets will remain robust.
Big demand on less limited supply implies earnings compression, but not an earnings wipe-out. Overall, the Street thinks earnings will hit $6.20 in fiscal 2020, versus $7.80 in fiscal 2018.
Micron has traded around 13x forward earnings in the past, but that forward multiple has fluctuated significantly based on the chip supply-demand situation. It looks like the market is comfortable paying 11x forward earnings for MU stock when earnings appear stable, as they should be by 2020.
An 11x forward multiple on $6.20 fiscal 2020 estimates implies a fiscal 2019 price target of $68. Discount that back by 15% per year (higher than my normal discount rate to account for risks inherent to the supply cycles in the semiconductor space), and you get to a present value of over $50.
Bottom Line on MU Stock
I’m buying this dip, while being mindful of the $50 level. This is a “buy now, sell later” type of stock.
As of this writing, Luke Lango was long MU.