For the entire second half of 2019, I’ve been waving the bull flag on shares of memory chip maker Micron (NASDAQ:MU) and I maintain the view that Micron stock is a long term winner.
My enthusiasm (see here, here, and here) is bolstered by easing U.S.-China trade tensions, falling memory chip inventory levels, and rebounding economic activity all pointed towards the fact that Micron’s core memory market was close to bottoming, and due for a huge rebound.
Fast forward to the last few weeks of 2019. MU stock is up 40% in the second half of the year, as it has become increasingly clear that the bottom for Micron is rapidly approaching.
Indeed, it is already here. In a mid-December conference call with investors, Micron management said that the current quarter represents the cyclical bottom in the company’s financial performance. Going forward, things will get better. Revenue trends will rebound. Gross margins will rebound. Operating margins will rebound. Profits will start growing again.
As all those positive catalysts materialize over the next twelve months, Micron stock will soar above $60.
Consequently, I don’t think it’s time to fade the rally in MU stock. Instead, I’m sticking with the rally. This stock isn’t done moving higher yet.
The Bottom Is In
The big idea behind the bull thesis on MU stock is that the bottom is in, and things only get better from here.
Taking a step back, it’s important to understand that Micron is a highly cyclical company which operates in a memory chip market that goes boom and bust with constantly changing supply-demand dynamics.
That is, Micron goes boom (revenues, margins, and profits all rise) when demand in its core memory markets is bigger than supply. But, those golden eras don’t last forever, because eventually, producers want to make more money and get more market share, so they keep building out supply. Then, demand hits a hiccup. It drops against the backdrop of elevated supply levels. And Micron goes bust (revenues, margins, and profits all fall) as supply outstrips demand.
From 2016 to 2018, Micron was booming, thanks to robust next-gen technology tailwinds pushing up demand in the memory market. Then, in 2018, escalating trade tensions coupled with rising geopolitical uncertainty and slowing economic activity curtailed memory market demand. Micron went bust, with revenues, margins, and profits all falling off a cliff.
At the end of 2019, it appears this bust period is coming to a close. U.S.-China trade tensions are easing, and global economic activity is picking back up. Thus, it’s no surprise that Micron’s revenues are starting to grow sequentially, and that gross margins are starting to stabilize.
All of these favorable trends will persist, and even accelerate in 2020. Revenues will start growing again on a year-over-year basis as memory market demand accelerates higher on the back of easing trade tensions. Margins will push higher as memory market demand outstrips supply. Profit growth will come roaring back.
Against this favorable backdrop, it’s not hard to see MU stock moving higher.
Micron Stock Will Take out $60
To be sure, most of the upside in MU stock has already been realized. Shares are up 75% year-to-date. But, not all of the upside has been realized, and there’s enough upside potential here to warrant staying long into 2020.
Micron’s revenues have fallen off a cliff. Trailing twelve month revenues are just over $20 billion. Back in 2018, this company did $30 billion in sales.
It is quite likely that Micron gets revenues back above the $30 billion level within the next few years, for several reasons. For one, 2019 was just a hiccup in an otherwise favorable secular growth backdrop (all of tomorrow’s most important technologies, including AI and IoT, require parts from the memory market to work efficiently, and therefore, demand should rise steadily for the foreseeable future).
At the same time, gross margins should rebound back towards their 2018 levels of 50% and up, as renewed demand pushes prices in the market higher.
Micron won’t have to do much by the way of upping expenses (since most of the growth will come from a demand rebound), so there’s no reason the company’s operating expenses should grow that much going forward. That leaves ample room for positive operating leverage as revenues march from $20 billion to $30 billion.
Net net, Micron is looking at huge profit growth potential over the next few years, powered by big revenue growth and huge margin expansion. Indeed, the Street consensus fiscal 2022 earnings per share estimate sits well north of $7, versus the $2.25 estimate for fiscal 2020.
Conservatively, then, Micron’s earnings per share should hit at least $7 by 2022. Based on a historically average 10-times forward earnings multiple and a 10% annual discount rate, that equates to a 2020 price target for MU stock of over $60.
Bottom Line on Micron Stock
The cyclical bottom is in for Micron. That means things will only get better from here. As they do get better in 2020, MU stock will keep moving higher, and my math indicates that prices above $60 look doable within the next few months.
As of this writing, Luke Lango was long MU.