When it comes to shares of cyclical memory-chip-maker Micron (NASDAQ:MU), my investment thesis has been very simple. Buy MU stock when the music is playing. Sell when the music isn’t playing.
For Micron, the music is playing when the company’s core memory chip market supply/demand fundamentals are favorable. That is, when memory chip market demand is outpacing supply, Micron’s revenues go higher (they sell more chips), as do margins (they sell those chips at higher prices). Big profit growth follows suit, as do big gains in the stock price.
Look back at 2016 to 2018. Memory chip market demand surged higher behind secular data tailwinds. Supply levels remained in check and Micron’s revenues went from ~$10 billion to ~$30 billion. Earnings per share went from near zero to $10-plus and Micron stock soared from $10 to $60.
On the flip side, the music isn’t playing for Micron when market fundamentals are unfavorable. And that happens from time to time. Demand fades every few years for various reasons, and supply expands every few years for various reasons, too. When those two things line up, supply outpaces demand, Micron’s revenue drops and so do margins, profits, and the stock price.
See 2018 to 2019. Demand faded amid escalating trade tensions while supply levels remained high. Micron’s revenues dropped from $30 billion to $20 billion, earnings per share fell from $10-plus to $3 and Micron stock plunged from $60 to $30.
In 2020 though, the music has started playing again for Micron. That’s why MU stock has rallied big over the past few months. And I anticipate this music will keep playing over the next few quarters, and as it does, MU stock will keep moving higher.
Listen to the Music
When it comes to Micron stock, you have to listen to the music. And right now, the music is playing loud and clear.
Throughout 2018 and 2019, the world was stuck in a synchronized global economic slowdown thanks to mixed central bank policies (the Federal Reserve raised rates throughout 2018) and escalating global trade tensions. Against this slowing and unstable economic backdrop, corporations eased capital spending. This killed demand in the global semiconductor market — which derives all of its demand from capital spending — at the same time that supply levels in the market were sky-high thanks to huge demand growth in several of the previous years.
Net net, weakening demand converged on record high supply levels for the industry in 2018 and 2019, and created huge revenue, margin and profit headwinds for most semiconductor companies, including Micron.
In 2020 though, everything has changed.
Monetary policy across the globe has eased, with rates everywhere at or near record lows and many central banks expanding their balance sheets at robust paces. Concurrently, U.S.-China trade tensions have meaningfully eased. The global economy is picking up steam, and as it does, corporations are re-accelerating their capital spending, providing a demand boost to the semiconductor market and fixing the market’s oversupply issue. This will all persist for the foreseeable future, because no one (not central banks, not China and not the U.S.) wants to upset the egg carton before the U.S. presidential election.
So for the next few quarters, strengthening demand will converge on reasonable supply levels in the semiconductor industry and create huge revenue, margin and profit tailwinds for most companies, including Micron.
Micron Stock will Keep Pushing Higher
With revenues, margins and profits set to move materially higher over the next few quarters and years, Micron stock is ready to push higher, too.
The rationale is fairly simple. If you look at prior cycle changes in Micron (i.e., when the company goes from shrinking to growing, or from growing to shrinking), the cycles typically last several quarters, if not years. That is, these are not quarter-to-quarter changes. They are longer term in nature then that.
Micron is likely to start growing again within the next two quarters. Assuming this “up cycle” has a similar duration to other “up cycles,” Micron is positioned to remain in growth mode well into 2021 and 2022. That’s why, when I look at Wall Street consensus estimates calling for $5.50 in earnings per share in 2021 and $7.50 in earnings per share in 2022, I think those targets are entirely achievable.
Let’s assume they are. MU stock normally trades around a discounted 10-times forward earnings multiple to account for its volatility. Based on a 10-times forward multiple, $7.50 in 2022 earnings per share implies a 2021 price target of $75. Discount that back by 10% and you arrive at a 2020 price target of nearly $70.
Micron stock trades below $60 today. Thus, shares look fundamentally positioned to keep running higher for the next few quarters.
Bottom Line on MU Stock
Buy Micron stock when the music is playing. Sell Micron stock when the music isn’t playing.
Right now, the music is playing loud and clear for Micron, and that music will only get louder and clearer over the next few quarters. As it does, MU stock will keep pushing higher, likely to levels above $60 and closer to $70.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
