I don’t like it when stocks trade at extreme valuation discounts because too many investors believe this is a catalyst for higher prices. It’s not, and all we need to do is look at Micron Technologies (NASDAQ:MU) to realize it. MU stock has traded a low valuation for the last few years and yet, it was never a catalyst that pushed the stock higher.
Of course, Micron stock has gone higher, but that’s only as the DRAM cycle held up better than many investors and analysts were expecting. It’s also because earnings and revenue continued higher.
Too many investors look at MU’s price-to-earnings (P/E) ratio and use that to justify a position. But the valuation — particularly the P/E ratio — is just one consideration, not the only consideration to choosing a position. For instance, when MU stock was at $60 a share, it traded at ~5 times current year earnings expectations. Dirt cheap right?
Well now that shares are down over 35% at $38, Micron stock trades at 3.8 times this year’s earnings expectations. The valuation didn’t help much, did it?
Valuing MU Stock
I don’t want readers to think the valuation is bad. Of course a P/E in this neighborhood should get investors’ attention, particularly when Micron is earning what it is.
So how is business? After earning more almost $12 per share last year in non-GAAP EPS, analysts expect Micron to earn $10.25 this year and $9.54 next year. On the revenue front, forecasts call for a 60-basis-point-increase this year and a 20-basis-point-decrease next year. So essentially, expectations are calling for flat growth over the next two years and an erosion of the bottom line.
That erosion is being caused by a few things, one of which is tariffs. Management said those have recently gone into effect and will eat into profits. NAND margins are under pressure too.
DRAM Prices
The better news is DRAM, which accounts for about 70% of revenue. Last quarter, DRAM average selling prices (ASPs) were flat year-over-year. In other words, it didn’t see the pricing power deflation that some analysts were expecting. We also got a hint from the Cisco Systems (NASDAQ:CSCO) conference call on Nov. 14, following a very good quarter.
CFO Kelly Kramer said DRAM prices continued to climb while supplies remained tight in 2017 and 2018. “So our strategy was securing supply. We bought inventory ahead. We did everything we could to try to minimize the impact. We had big purchase commitments and we are still seeing year-over-year price increases in this quarter.”
Kramer said these headwinds should ease sometime in fiscal Q2 (the current quarter) and become a tailwind in Q3 and Q4. That would be bad for Micron stock in my mind. But she also just told us that Cisco has been increasing its orders to build an inventory. She’s not saying that prices are falling and Cisco’s reaping the reward. Just that, like an airline company knowing fuel costs will climb, they opted to buy when they could at better prices.
Maybe that shows slack in the supply market. Maybe it suggests MU has one more good quarter left. But to me, DRAM hasn’t completely fallen apart yet and that bodes well for MU stock.
Trading Micron Stock
Above is a five-year weekly look at Micron stock. MU is resting just above this $35 to $38 band of support. It’s a scary time in the stock market, where even studs like Apple (NASDAQ:AAPL) and Nvidia (NASDAQ:NVDA) find themselves in bear market territory. Perhaps they are better buys than Micron at these levels.
But given the valuation and steady outlook on DRAM, I’m not sure it should be ignored. All I know is that this $43 billion company has about $4.5 billion in total debt, almost $7 billion in cash and had a net income of more than $14 billion in 2018. If it can clear $10 billion in each of the next two years — it should — it will prove to be too cheap at these levels.
If support holds up, investors have a reasonable risk/reward on their hands. They can take a small position initially and add to that position once MU stock hurdles its 10-week moving average. This mark has been resistance and is at roughly the same level as the 50-day moving average, for those who look at the daily chart.
Below support and they cut-and-run.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, he was long NVDA and AAPL.
