As Micron (NASDAQ:MU) approaches its $50 yearly high, investors must ask themselves if MU stock will continue marching higher. Much of the rally is built on two premises: the U.S.-China trade war is on pause and stronger chip demand is expected for the rest of the year. To argue the bullish case, assume for a moment that these expectations prove accurate.
China’s retaliatory tariffs on $75 billion worth of U.S. goods are but a distant memory. Micron stock fell to the low $40’s on Aug. 23. But when the U.S. announced no immediate trade negotiations or progress and instead pointed to talks resuming in October, MU stock soared. It added another 8.5% in the last week, closing recently at $49.13. And since the market is pricing expectations for the future, investors may expect tariffs staying. Suppliers now know exactly what extra taxes they face, so knowing how much costs change will allow them to adjust output accordingly.
MU stock was not the only winner in the last week. In that time, Intel (NASDAQ:INTC) rose 8.9% while Nvidia (NASDAQ:NVDA) rose 7.8%. Oddly enough, Advanced Micro Devices (NASDAQ:AMD) did not participate in the rally, falling 3% in the last week. Micron stock may benefit from being among the cheapest semiconductor stocks at a price-to-earnings ratio of 5.8X. As business returns to normal levels, investors may find MU stock is still trading at a discount.
Micron is confident that the long-term outlook for memory and storage is compelling. Secular trends, such as AI, autonomous driving (ADAS), IoT and 5G, will not just go away because of the troubling trade wars. In the last quarter, Micron benefited from customer inventory improvements. Given that positive development, Micron forecast demand for DRAM (memory chips) returning to healthy year-over-year growth in the second half of this year.
Micron also forecast NAND (used in solid state storage) bit demand increasing in most of its markets. Although chip suppliers suffered from weak pricing power for NAND in the last year, that trend stimulated demand. The rebound in NAND demand justifies the recent rally in MU stock. But to drive profit margins higher, Micron cut capital expenditures to align industry supply with current demand levels.
MU: Pushing Innovation
Micron now attributes high-value solutions to two-thirds of NAND revenue. It launched data centers that use high-speed NVMe SSDs for cloud and enterprise markets. And in the third quarter, it more than doubled shipments of its NVMe client SSDs to large PC OEMs.
In the mobile market, the company offers mobile DRAM products that are extremely energy efficient compared to the competition. In Q3, DRAM shipments for the enterprise were at levels higher than management expected. It forecast continued demand momentum for the current Q4 period.
Headwinds Bearing Down on MU Stock
Restrictions against Huawei hurt NAND revenue and shipment levels. If the U.S. did not impose such restrictions, DRAM and NAND revenue would have met the company’s high end of guidance. In the remote chance that the U.S. and China agree on a trade deal, the U.S. may lift the tough restrictions Huawei now faces.
Micron increased its NAND inventory levels for calendar 2019 and 2020 in anticipation of higher demand. It also held above-average DRAM inventory for the same reason. If the expected demand does not arrive, Micron may have to sell excess inventory at reduced prices.
Valuation and Your Takeaway
Micron knows better than investors and analysts what demand levels will be like for the rest of the year. Although it did not issue a FY 2020 forecast, its expectations for stronger demand will lift its profit margins. Investors may assume that in a 10-year DCF Revenue exit model, a revenue exit model of 1.5 times to 2.5 times.
Micron reports results after the market closes on Sept. 26. If it confirms that strong demand is ahead, then the stock has more upside.
As of this writing, Chris Lau did not hold a position in any of the aforementioned securities.