When it comes to Micron Technology, Inc. (NASDAQ:MU) stock, it’s all about owning the stock while the music is still playing (end-market demand growth exceeds chip supply growth). As soon as the music stops (supply growth exceeds demand growth), things gets ugly, and MU stock drops like a rock.
Fortunately for investors, Micron just reported first-quarter numbers, and they resoundingly underscore the thesis that the music hasn’t stopped yet.
From head to toe, the report blew expectations out of the water.
Revenues came in at $6.8 billion. Management had guided for $6.3 billion. Gross margins were 55%. Management had guided for 52%. Operating income was $3.2 billion. Management had guided for $2.75 billion. Earnings per share were $2.45. At best, management thought EPS would be $2.23.
Things were just as impressive on the guidance front. Revenue is expected to be $7 billion next quarter. The Street was looking at $6.2 billion. EPS is expected to be $2.51, at worst. At best, the Street was looking at $2.30. Gross margins are expected to be 56%, continuing their upward path.
Moreover, cash flows were robust, cash on the balance sheet was up, debt was down and the call went really well.
What more could you ask for in a quarterly earnings report?
Not much. Consequently, now looks like a really good time to own MU stock.
But I don’t think that means MU stock is one to own forever. I remain concerned about supply growth in 2018 and after, and still believe that 2018 will represent peak earnings in this cycle.
All in all, I like MU stock to the mid-$50’s. Here’s how I get there.
MU Business Is In a Great Place
In fact, the entire Micron business is on fire right now.
The data center business is on fire, driven by especially strong demand from cloud customers. Q1 SSD revenue to cloud and enterprise customers jumped 50% higher sequentially, while DRAM bit shipments to both cloud and enterprise customers increased by more than 50% year-over-year. Robust demand here will persist as data continues to migrate to the cloud.
The mobile business is on fire (record mobile revenue in Q1), and will likely accelerate in the future as smartphones only get smarter. As this happens, demand for higher-capacity memory solutions and increased storage in mobile devices will ramp. Again, robust demand here will persist.
The Internet of Things (IoT) business is on fire, driven by an explosion in the number of smart devices (namely, smart home products). Just like smartphones, as these IoT devices get smarter, demand for MU chips will grow.
The graphics business is on fire, with record revenue that was up more than 75% year-over-year. This is where MU has exposure to the secular eSports tailwind. ESports is primed to be the “next big thing” in the gaming world, so this is a tailwind that will persist into the foreseeable future. There is also some cryptocurrency mining playing a factor here. That is less secular of a tailwind, but nonetheless a nice boost to the business in the near-term.
And lastly, the automotive business is on fire. According to management, automotive customers are rapidly moving to new memory technologies, and doing so at an unprecedented pace. MU has new products lined up to support this boosted demand. As autonomous driving really starts to go mainstream (we are only at the tip of the iceberg), this business for MU will boom.
Supply-Demand Dynamics Remain Favorable … For Now
Perhaps most importantly, the quarterly report underscored that the supply-demand dynamics underpinning robust profits remain exceptionally favorable. Gross margins were at 55%, up 29 percentage points year-over-year. That helped operating margins jump to 46%, up 35 percentage points year-over-year.
But supply growth is coming, and while robust demand growth will help offset a supply-side boost, currently favorable supply-demand dynamics will grow less favorable by next year.
The market is expected to get flooded with supply to match this robust demand, especially on the NAND side. MU is partially protected from this since 67% of revenue is DRAM, and the projected DRAM supply growth of 20% in 2018 will likely lag demand growth.
But MU is still at risk to supply increases. This means gross margins will trend down next year, which will drag meaningfully on profits.
Bottom Line on MU Stock
I maintain that this is a stock to own now while the music is still playing, but not forever.
Given the huge quarter, I think fiscal 2020 earnings estimates will come up from $6.20 to around $6.50. I maintain that MU stock will warrant an 11x forward earnings multiple at that time (see rationale here). That implies a fiscal 2019-end price target of $71.50.
Discount that back by 15% per year, and you get to a fair value of about $54.
I like MU stock to about that level.
As of this writing, Luke Lango was long MU.
