Chipmaker Micron (NASDAQ:MU) was once one of the hottest investments on Wall Street. From May 2016 to May 2018, MU stock roared from under $10 to above $60 as revenues and earnings dramatically improved — thanks to a convergence of operational tailwinds in the memory market.
Since peaking in May 2018, though, MU stock has struggled. The stock has been on a slow and gradual grind lower. Today, MU stock changes hands just above $50.
Time to buy the dip? I think so. Micron is a solid company with healthy go-forward fundamentals. Granted, supply ramp in the memory market will drag on earnings power in the near-term. But demand in the memory market will remain healthy enough to support strong earnings — and those strong earnings will be enough to support a $70-price tag on the stock.
Plus, $50 is a nice, round number which MU stock has bounced off of before. I think that will happen again in the near future.
Here’s a deeper look.
Supply Ramp Is Scaring the Market
MU stock roared from $10 to $60 in two years because the supply-demand fundamentals in the memory chip market were increasingly favorable for suppliers like Micron.
Namely, demand was robust because end-markets like data centers, Internet-of-Things (IoT), autonomous driving and Artificial Intelligence were emerging to the forefront. Meanwhile, supply was constrained because this new flood of demand required complex chips, the likes of which were being made in limited quantity. Thus, the past two years in the memory chip market have been defined by big demand, low supply. That favorable supply-demand backdrop has created a surge in Micron’s profit margins.
But that golden era appears to be ending soon.
The supply ramp is coming. This always happen in the memory chip market. Eventually, big demand is met with big supply, and profit margins for suppliers like Micron slip. According to multiple analysts and market observers, it looks like this supply ramp is just around the corner. Earnings in 2019 are expected to decline.
Negative earnings growth usually leads to poor stock price performance. As such, investors are bracing early, and MU stock is dropping this year.
Demand Will Support Strong Earnings
Aforementioned supply ramp concerns are significantly overstated and lack an understanding of the company’s demand tailwinds.
Demand in the memory chip market is at a record highs right now due to big demand from data center, IoT, autonomous driving and AI markets. Each of those markets are nascent in the big picture, and will remain big growth markets for the next three to 10 years. Thus, Micron will likely benefit from huge demand for the next three to 10 years.
That big demand should allow Micron to sustain strong earnings power even against supply ramp headwinds.
Normally, these supply ramps last two years, and cause earnings per share at Micron to drop $4 during that stretch. There is reason to believe that this upcoming decline will be greatly mitigated relative to historical standards due to robust demand tailwinds. Nonetheless, let’s use this $4 peak-to-trough earnings decline as a base for what could happen over the next two years.
Earnings this year (fiscal 2018) are expected to peak around $12 per share. Thus, history says that earnings will shake out around $8 per share by fiscal 2020.
Over the past five years, MU stock has historically traded around 9X forward earnings. Applying that historically average 9X forward multiple to $8 in earnings per share in fiscal 2020 implies a fiscal 2019-end price target of $72.
Thus, over the next 12-16 months, I reasonably see MU stock rising by more than 40%, even in the face of supply ramp headwinds.
Bottom Line on MU Stock
Supply ramp concerns have merit, and such headwinds will prevent MU stock from heading towards $100.
But, demand from markets like data centers, IoT and AI will remain robust enough to offset supply ramp, and Micron should be able to maintain a healthy earnings base.
As such, at $50, MU stock looks priced for disaster and not reality. I think that means it is time to buy the dip.
As of this writing, Luke Lango was long MU.