Micron (NASDAQ: MU) stock is on a tear. MU stock has rallied from less than $33 at the end of June to over $47 today. Several factors, including a surprise earnings beat and the possible U.S.-China trade war detente, have improved investors’ confidence in the semiconductor manufacturer’s future prospects.
But can Micron stock rise further? Could trade relations between the U.S. and China deteriorate further? Read on to learn more about the risks and opportunities provided by MU stock.
What’s Behind the Recent Rally of MU Stock?
What has propelled Micron stock up about 40% in the last month? A strong earnings report, for one. While its sales slumped from $7.8 billion in the fiscal third quarter of FY18 to $4.79 billion in Q3 of FY19, Micron beat analysts’ average estimates last quarter, forecasting increased demand in the current quarter for both DRAM and NAND memory chips.
Another strong factor behind Micron’s rally is the easing of tensions between the U.S. and China , including the resumption of sales by U.S,. firms to Huawei. As InvestorPlace contributor Brad Moon pointed out in a recent article, half of Micron’s sales come from China, with Huawei alone providing 17% of MU’s revenues. Micron lost big when the U.S. government banned sales by American companies to Huawei, and MU would have been meaningfully, negatively affected if the trade war had accelerated.
But despite this bit of good news, MU still has risk from China. While the two powers are mutually dependent on each other for trade, international relations could turn on a dime. Taking a position in MU stock is a big bet on a trade-war resolution.
The third factor that has boosted Micron stock is the Japan-South Korea trade war. The spat started when South Korean courts began ruling in favor of compensation for people subjected to forced labor during the Japanese occupation of Korea. Japan believes this issue was settled long ago and refuses to back down. Tokyo has retaliated by banning the export of chemicals vital to semiconductor production to South Korea.
This trade dispute could raise the price of semiconductors, and reduce a global inventory glut of the chips. That would be good news for Micron, which, like the rest of the chip sector, needs signs of a demand pickup to move the needle for its stock. MU has a large amount of inventory. The company has 151 days of inventory on hand, nearly twice that of its competitor, Samsung.
Regarding the Japan-South Korea trade war, there are a few caveats. Some analysts believe that the trade restrictions will have minimal impact on memory-chip demand. This shows that DRAM/NAND prices won’t rise without additional positive catalysts.
Cheap on Paper, But Future Earnings Impacted by Chip Glut
Investors looking at Micron’s current fundamentals may see the company as a screaming buy on value alone. That’s because:
- Its trailing 12-month price-earnings ratio is five
- Its forward P/E is eight
- Its enterprise value/ EBITDA ratio is 2.9
But these low earnings multiples must be taken in context. MU’s earnings are expected to decline, due to the oversupply glut. DRAM and NAND prices need to pick up before MU’s earnings can rebound.
Analysts’ estimates for MU’s 2020 earnings per share range from $1.07 per share to $2.44 per share. Compare that to MU’s diluted EPS over the last year of $8.65, and it is clear that MU ‘s PE ratio is not low.
However,investors who buy MU stock may be getting a strong entry point, even if they are not buying Micron stock at the bottom. MU stock will still have significant runway if the memory chip market materially improves over the next few years.
The question is, when will the semiconductor market turn around? Will an economic slowdown in the next two years reduce memory chip demand further? There are many factors that make the outlook of MU stock tough to determine.
MU Stock Feels Like a Value Trap, But Could Go Higher
A global glut in semiconductors, especially memory chips, has beaten down MU stock. Assuming that that the chip market has not yet bottomed, it could take years for MU’s earnings to rebound.
At current multiples, MU stock looks like a deep value play. But its low valuation is a lagging indicator, as seen from analysts’ future earnings estimates. Investors should not view the trailing and forward P/E ratios as clear signs that Micron stock is cheap. MU’s negative future outlook coupled with a deceptively low trailing earnings multiple make MU stock feel like a value trap.
However, with macro factors improving Micron’s prospects, MU’s fiscal Q4 results could beat expectations , sending Micron stock even higher.
Micron stock may have bottomed when its book value previously dropped to $32 per share. Investors may get a strong buying opportunity if shares fall back to that level. Nevertheless, MU stock’s risk/return ratio may be favorable at its current levels.
As of this writing, the author did not own shares of any of the companies mentioned.