On its face, the valuation of Micron Technology (NASDAQ:MU) seems absurd. MU stock trades at 3.5 times analysts’ consensus fiscal 2019 EPS estimates. That valuation alone seems to suggest huge upside for Micron stock.
But MU is a $43 billion stock and one of the largest semiconductor companies in the world. The seemingly ridiculous multiple isn’t a case of the market not paying attention. As I detailed back in September, there’s a legitimate bear case for Micron stock. The company’s earnings will probably decline and could sink sharply. This is one of the most cyclical companies in the world and right now, the cycle looks set to turn against MU.
At the same time, however, I argued a month later that MU stock was set to bottom, as it had become simply too cheap even if the bears were right. Micron stock did rally, but it has since returned to those levels and is now testing its lowest point in over a year.
Now near its lows again, MU stock still looks too cheap. Indeed, some of the risks that were previously embedded in the stock have come to pass, but that only seems to prove the point that $35 is too little to pay for Micron stock.
Micron Stock Models Come Down
When MU stock was at similar levels six weeks ago, my case for Micron stock was based on the idea that much of the downside already seemed priced into MU. The company’s earnings were expected to decline, as analysts on average forecast that its earnings per share, excluding some items, would drop 12% in fiscal 2019 (which ends in ending August) and fall another 7%+ the following year. Yet the same analysts who modeled those declines still saw value in Micron stock; their average price target for MU stock stood at $67.
Based on that data, one obvious risk was that analysts were going to have to catch up with the company’s performance. Concerns about DRAM pricing, in particular, likely hadn’t been baked into analysts’ estimates for MU. As estimates were cut, analysts’ targets for MU stock would likely head down as well.
And indeed, some of that pressure from the Street has come to bear. Analysts’ average fiscal 2019 EPS estimates have come down to $10, against $10.61. Consensus FY20 projections dropped to below $9 from close to $10. And the average price target for MU stock now is $61, not $67.
But MU stock is at $35, meaning that. Micron stock still trades at less than four times the consensus FY20 EPS estimate. And Micron stock is trading under eight times the lowest of 25 estimates for FY20.
It’s too optimistic to argue that the absolute worst-case scenario is priced in. Memory prices could collapse (though I think that’s unlikely), causing Micron’s earnings to tumble. But an awful lot of downside is incorporated into MU stock price.
Will Earnings Hurt or Help Micron Stock?
That said, Micron stock does have a potential hurdle ahead, as it’s due to report its fiscal Q1 earnings next week. MU’s Q4 earnings handily beat expectations, but MU stock sank anyway. MU then got caught up in the broad market weakness that hit other chip stocks like Nvidia (NASDAQ:NVDA) and Advanced Micro Devices (NASDAQ:AMD). MU stock subsequently reached a 52-week low.
The obvious risk to MU’s Q1 results is weak guidance. The market’s reaction to the Q4 results seems to suggest that investors have their eyes firmly on the company’s outlook and are not going to bid MU stock up based on the company’s backward-looking results. The recent rallies of NVDA and AMD have fizzled. So have those of equipment manufacturers Lam Research (NASDAQ:LRCX) and Applied Materials (NASDAQ:AMAT), which are exposed to similar cyclical forces as Micron.
Though I remain bullish on Micron stock, I’m not sure that the company’s Q1 report is likely to be a catalyst. Simply put, Micron’s earnings aren’t going to convince investors that the cycle isn’t turning negative or that Micron isn’t cyclical at all.
Of course, MU stock is still cyclical, and memory prices and earnings will probably come down. But memory demand should strengthen over the long-term, and (hopefully) the industry has learned its lessons from the oversupply that crashed memory prices in 2015-2016.
Meanwhile, MU stock is priced as if the world – or perhaps just MU’s business – is coming to an end. It’s not. And investors will figure that out at some point, perhaps as soon as next week.
As of this writing, Vince Martin has no positions in any securities mentioned.