Valuing a cyclical play like Micron Technology (NASDAQ:MU) stock is difficult for two reasons. In theory, valuation should be based on so-called “mid-cycle” earnings, but calculating those earnings isn’t easy when it comes to MU. And volatile earnings like those of MU can lead to volatile trading, which is exactly what we’ve seen from Micron stock.
Indeed, in the last three years, MU stock has moved from under $20 to over $60 to a current price just north of $43. And its earnings have been all over the map. Micron was unprofitable in fiscal 2016 – and earned almost $12 per share on an adjusted basis in fiscal 2018.
Its EPS will likely head below $3 in fiscal 2020, based on analysts’ average estimate. And so after MU stock looked almost absurdly cheap, at one point trading below four times its non-GAAP EPS, now, at 17 times its forward earnings. it looks reasonably valued at best,
The issue with Micron stock at the moment is that the two ways of evaluating the stock seem to point in different directions. Fundamentally, I still see MU stock as a buy. Indeed, this summer I called it one of the best S&P 500 stocks to buy.
But technically, the selloff following its Q4 earnings makes some sense. Like the Q4 report – which I thought was more concerning than investors seemed to believe – the company’s Q1 guidance looked disappointing. Given the results and guidance, there’s not enough evidence to believe a bottom in MU stock has been set for good.
Some investors may choose to focus on the company’s long-term outlook and ride out any near-term volatility in Micron stock. I wouldn’t blame them. But more aggressive investors might want to wait for a better entry point that may well be available in coming months.
Is the Bottom in for MU Stock?
In theory, the multiple of a cyclical company like MU should contract at the top of cycles and expand at the bottom. That explains why the multiple of MU stock was so low last year: investors were (correctly) anticipating that MU’s earnings would decline. And it also explains why investors are paying over 16 times earnings for Micron stock even as MU’s profits are tumbling.
But in practice, the Street’s outlook isn’t always accurate. Investors and analysts get too optimistic at the top, and they get too pessimistic at the bottom. Both phenomena have affected Micron stock in recent years.
And so one of the tricks to trying to buy a cyclical stock is not just timing the fundamental bottom or top, but trying to time when investors’ sentiment will shift. Cyclical stocks usually turn a couple of quarters before their businesses do. That has been the case with MU. But investors don’t always correctly price companies’ fundamentals into their stocks ahead of time.
Those who buy Micron stock above $40 may be overly upbeat about the company’s future performance. Its Q4 and Q1 guidance both came in below analysts’ average estimates. And some short-term factors boosted the results of both quarters.
Per MU’s Q4 conference call, its customers in China are building inventory ahead of potential tariffs and political dislocations. Cost declines have been steeper than they will be going forward.
The bounce of MU stock since the company’s Q3 report suggests that investors are pricing in a cyclical recovery starting as soon as next year. I’m far from convinced that such a recovery is on the way.
Given the current valuation of MU stock, the company’s earnings and price-earnings multiples may both drop, pushing MU stock back to $30 or lower.
The Fundamental Case for Micron Stock
That said, I still believe MU stock can rise over the long-term. At this point, estimating its mid-cycle earnings is difficult, given the large changes in its annual profits. But as management said before and reiterated on its Q4 call, MU and its industry have improved over the last three years.
Its production capacity has been reduced, enabling it to spend less on equipment. For the most part, its rivals like Samsung are also cutting their production.
Moreover,the prices of MU’s products are reasonably intact. The hope is that the boom and bust nature of its business will moderate, even if it likely never will completely end.
Last year’s $11.95 of adjusted EPS obviously represents a peak for MU. And given multiple factors, it may not be a peak to which Micron returns any time soon. But with adjusted EPS still likely to come in above $2 this year, it does seem like mid-cycle EPS conceivably could be $4 or $5.
I’d certainly rather own Micron stock than, say, Intel (NASDAQ:INTC), given the likely long-term tailwinds for both DRAM and NAND memory that will benefit MU. But on the other hand, MU doesn’t have the linear growth potential of Advanced Micro Devices (NASDAQ:AMD) or the diversification of Broadcom (NASDAQ:AVGO). However, MU’s earnings still can rise.
Assuming MU’s mid-cycle EPS is $4+, that suggests the fair value for MU stock still should be above $50. And if supply and demand trends become more favorable than expected, Micron stock can rise still higher.
But the question remains: when can that happen? With the market – including chip stocks – weakening, and MU’s Q1 results likely to look soft, MU lacks a catalyst. So while I do expect MU stock to climb above its current level, I don’t know that I necessarily expect it to rally any time soon.
As of this writing, Vince Martin has no positions in any securities mentioned.