Micron (NASDAQ:MU) stock finally delivered the rally investors were waiting for. Micron stock gained 47% in just 20 trading sessions. As a result, MU moved to its highest level in almost eleven months.
The rally makes some sense. I made the case for the stock in late June, calling it one of the 10 best S&P 500 stocks to buy. A price in the low- to mid-$30s seemed far too low, even with earnings likely to decline. Fiscal Q3 earnings crushed Wall Street expectations, and as a result, analysts have jumped on board.
But after these enormous gains, I’d be very careful with Micron stock here. In fact, I’d take profits and be on my way. We’ve seen these moves in MU and other chip stocks before; they don’t always end well. I didn’t think earnings were nearly as impressive as investors seemed to, and the Street often has been a contrary indicator when it comes to MU stock.
More broadly, there’s a bear case here as I tried make clear when Micron stock traded at a seemingly unbelievable 3x or 4x earnings. That bear case still exists — and it’s a lot easier to make right now.
The Cyclical Issue for Micron Stock
It might somewhat ironic that MU stock is rising as its earnings are falling. After all, even though Q3 earnings beat expectations, the numbers still were reasonably grim. Adjusted EPS declined by two-thirds year-over-year — even with a one-time tax benefit the company didn’t exclude from its non-GAAP figures.
But MU stock is behaving how a cyclical stock should behave, at least in theory. Earnings multiples should contract near the top and expand at the bottom. And so MU traded at 3-4x earnings as those earnings peaked. It now trades at a seemingly reasonable 19x FY20 analyst EPS estimates.
That said, there are two factors that make the current expansion worrisome, even if the multiple assigned MU stock should be rising.
Two Key Concerns for MU Stock
First, MU earnings estimates are falling — and falling rapidly. As I noted after Q3, Q4 guidance actually was weak relative to expectations. Micron is guiding for $0.38-$0.52 in per-share profit, below the $0.78 consensus ahead of the release.
More concerning is the fact that FY20 estimates are plunging. 60 days ago, consensus for next year’s EPS was $4.51. It’s now $2.49.
Secondly, there’s an increasing amount of information that suggests that ~$12 in adjusted EPS wasn’t really a cyclical peak, but simply a one-time confluence of factors that almost certainly won’t repeat. Demand soared at the same time the industry was cutting capacity. Prices rose, and because of growth in areas like datacenter, customers were relatively insensitive to those prices. Micron printed money in a way that it won’t be able to again.
Now, datacenter growth is slowing as companies like Nvidia (NASDAQ:NVDA) and Intel (NASDAQ:INTC) have detailed. Capacity is increasing in both DRAM and NAND. Micron’s earnings per share, in a few years, went from near-zero to $12 to $2-$3 next year. They’re likely not going back to $12, even if memory demand rises as most believe it will.
And so what’s the estimate for ‘normalized’, mid-cycle EPS? That’s really the question here because that’s how a cyclical stock should be valued. If FY18 was an aberration, the figure is likely closer to $4-$5. And that doesn’t make a $47 share price all that attractive.
Is The Street Wrong Again?
Wall Street has jumped aboard the MU story in recent weeks. Goldman Sachs (NYSE:GS) upgraded the stock last week. So did Deutsche Bank (NYSE:DB). Morgan Stanley (NYSE:MS) followed on Tuesday.
That said, I’m not sure that’s necessarily great news. Analysts haven’t been great on Micron stock in the past (although it’s admittedly a tough stock to cover). Few predicted the recent plunge. There’s certainly a sense of analysts simply chasing the stock, rather than the other way around.
More broadly, Wall Street’s reaction seems to confirm a sense that the market believes a bottom is in. There’s some evidence for that point. James Brumley has pointed out, for instance, that memory prices are rising. Western Digital (NASDAQ:WDC) has rallied as well. So have equipment manufacturers Applied Materials (NASDAQ:AMAT) and Lam Research (NASDAQ:LRCX), who are among the most cyclical stocks in the semiconductor sector.
But it’s not certain — or close to certain — that the bottom indeed is in. Datacenter demand remains choppy. PC sales have been surprisingly strong of late, but the long-term trend is negative. Supply is on the way. And, again, next year’s estimates are coming down, even as Wall Street analysts upgrade the stock.
Nearly 50% gains in that context are somewhat surprising and could be somewhat transitory. Micron stock in the last few weeks has priced in most of the good news. The risks, however, remain.
As of this writing, Vince Martin has no positions in any securities mentioned.
