Micron Stock Is Likely to Sink If Management’s Forecast Proves Too Rosy

Micron Technology (NASDAQ:MU) is not an easy stock to value from a fundamental perspective. Micron’s profits are more volatile than those of almost any company in the world. That makes estimating the fair value of MU stock on an earnings or cash flow basis more complicated than usual.

For Micron Stock, Management Had Better Be Right
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That issue has arisen in recent years. It was not that long ago that Micron stock traded for less than four times its earnings, a multiple that seemed simply ridiculous. Its profits, excluding some items, promptly fell 47% in fiscal 2019. As its earnings multiple expanded, MU stock retreated sharply from its 2018 highs.

Determining where MU is in its cycle is a key part of understanding the valuation and trading of MU stock. We know, for instance, that Micron generated almost $12 in earnings per share, excluding some items, in FY19 and lost 27 cents per share three years earlier. What’s up for debate is the company’s true earnings power.

Was FY19 a one-time event, driven by unusual supply constraints and peak demand? Are other memory developers, as they have in the past, going to increase their capacity, raising supply, undercutting prices and leading to a repeat of MU’s losses in FY16 and FY 12? Or do long-term growth drivers like 5G wireless and the proliferation of datacenters suggest that cyclicality will become more muted and earnings growth more consistent?

Investors and analysts can, and do, have very different answers to these questions. With MU stock rallying to an 18-month high on Tuesday, the market right now is choosing the more bullish answers. There’s one key reason for that choice.

Micron’s Management Calls the Bottom

Recent trends in our business give us optimism that our fiscal second quarter will mark the bottom for our financial performance, which we expect to start improving in our fiscal third quarter, with continued recovery in the second half of calendar 2020.

That statement was made by Micron CEO Sanjay Mehrotra on his company’s Q1 conference call in December. It’s not a coincidence that the statement was the third sentence of Mehrotra’s prepared remarks.

After all, MU’s Q1 results results weren’t that impressive. Micron did beat analysts’ average top-line and bottom-line estimates. But the beats were modest. Micron’s revenue still declined 35% year-over-year, and its earnings per share, excluding some items, fell 85% YoY.

Micron’s Q2 guidance seems little better. Micron’s outlook, at the midpoint, projects a 9% decline in revenue and a 27% drop in EPS quarter-over-quarter. Its profit guidance was well below the already-soft average estimate.

But Mehrotra was trying to get investors and analysts to look beyond Q2. He succeeded. MU stock gained 2.8% the following day even after a sharp rally ahead of its results. Micron stock subsequently traded sideways until Tuesday, when research firm Cowen upgraded the stock, causing MU to surge 8.8%.

The Bottom and MU Stock

Micron stock now has risen about 80% from its June lows. That rally indicates that a majority of investors think that MU’s CEO is likely correct, and that its earnings and sales are set to pick up in Q3 and beyond.

That matters for two reasons. In the near-term, it would be easier for MU stock to rally if its profits rise. But analysts’ FY21 estimates indicate just how uncertain its outlook is. The lowest estimate for its FY21 EPS is $2.65. The highest EPS estimate is $10. Micron stock is trading at a worrisome 22 times the lowest estimate — a huge and likely excessive multiple,  even if its earnings have bottomed. (Remember that cyclical chip names trade at a steep discount to the market, in part due to their cyclicality.) On the other hand, MU stock is trading at less than six times the highest FY21 EPS estimate — which means Micron stock probably can rise significantly above its current levels.

Looking forward, there is reason to be upbeat on MU. The bulls on Micron stock point to the idea that memory chip demand is going to rise going forward, allowing cyclical downturns to reverse quickly. If that scenario plays out in 2020, investors will believe that the risk of another painful, deep reversal down the line is low.

That, in turn, could enable the P/E multiple of Micron stock to expand and prompt analysts to increase their estimates for so-called mid-cycle earnings. That combination would cause the rally of Micron stock to continue.

The 2020 Outlook of MU Stock

And so, for at least the next two quarters, the CEO’s prediction seems likely to hover over Micron stock. If he is right, MU can climb further, even after its big rally.

Analysts already have been racing to upgrade MU stock. Mizuho, Morgan Stanley, and Wedbush all lifted their ratings and price targets on the stock heading into MU’s results.

The average Street target has gone from around $47 at the beginning of September to nearly $63 at the moment. The targets will keep rising if Micron keeps delivering, causing its medium-term to long-term fundamental outlook to improve.

That said, after this rally, there’s not much room for error. For MU stock to maintain its current levels, the CEO almost has to be right. The market is pricing in a rebound in the second half of 2020. With MU stock at an 18-month high, it’s not pricing in disappointment, even if that disappointment only lasts a quarter or two.

To be fair, there is a bit more going on now. The gains of the stock of memory rival Western Digital (NASDAQ:WDC) show that Mehrotra isn’t the only one who’s optimistic about the second half of this year. Other chip stocks like Nvidia (NASDAQ:NVDA), Advanced Micro Devices (NASDAQ:AMD), and even Intel (NASDAQ:INTC) have risen nicely in recent months on some of the same drivers.

But if the bulls are wrong about this year’s outlook, Micron stock may well fall along with those other names. At $35, MU stock wasn’t necessarily pricing in a near-term recovery. At $58, it is.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2020/01/micron-stock-management-better-right/.

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