Micron Stock Is Finally Climbing Out of a Cyclical Bottom

Micron (NASDAQ:MU) is climbing out of a cyclical bottom in its memory business. In December, Micron CEO Sanjay Mehrotra said that the second quarter will be the trough for its chip business. That bodes extremely well for MU stock.

Source: Charles Knowles / Shutterstock.com

Micron will report its Q2 earnings on March 25. The company has guided that revenue will be lower than in the previous quarter. It expects $4.5 billion to $4.8 billion. The midpoint of that guidance comes in 9.6% lower than the $5.1 billion in revenue reported for Q1.

However, I suspect that the dampening effect of the coronavirus on memory chip demand, especially in Asia, will hurt Micron’s business. That could push revenue down further than expected for Q2.

But analysts have been widely forecasting most of these negative growth expectations. So, in effect, the present MU stock price already implies this disappointment.

Nevertheless, analysts are looking past that expected downturn in terms of valuation for MU stock.

What Analysts Project for MU Stock

Analysts polled by Seeking Alpha expect revenue to dip to $4.7 billion in Q2. That is down 8.4% from the prior quarter. But this estimate is slightly better than the midpoint of the company’s guidance.

Moreover, analysts at Seeking Alpha expect non-GAAP earnings per share of 37 cents for Q2. This is significantly lower than the 48 cents per share earned by Micron last quarter.

Wall Street analysts are now more positive on MU stock. For example, Morgan Stanley analyst Joseph Moore says that demand is picking up for dynamic random-access memory (DRAM) chips.

He believes that the bottom will have  more of a V-shaped point. That is good for MU stock, so he raised his target price upward to $73 from $56. That is 40% above today’s price near $52.

Barron’s recently reported that Raymond James analyst Chris Caso had also upped his target price to $70.

He cited improving conditions for DRAM and NAND chips. For example, Apple’s (NASDAQ:AAPL) 5G iPhones and next-generation gaming consoles are catalysts for Micron. All of this leads to higher prices for MU’s chips.

That bodes well for MU stock. It is likely why it has been rising in the past two months — with the exception of a recent coronavirus-driven drop — since the last earnings report.

Moreover, steady free cash flow at Micron will likely also push up MU stock.

Micron’s Free Cash Flow Should Remain Positive

Micron has been able to avoid the heavy cash burn that it had during its last downturn in 2016. Bloomberg recently found that the wild swings under Mehrotra have improved.

For example, if the CEO’s predictions for 2020 pan out, this will be the fourth year in a row that free cash flow (FCF) stays positive. This will be the first time that the company has managed such a run.

MU stock - FCF History

Source: Mark R. Hake, CFA

You can see in the chart above that Micron’s FCF has swung wildly in the past 10 years. The columns in green represent the FCF generated by MU in billion dollars. The red line shows the year-to-year change.

In addition, I have included an estimate for 2020 FCF based on its average FCF margin. This represents the percentage of revenue that FCF represents over the years.

Note that the 2020 FCF margin is lower. This is because of the estimate for 2020 revenue, which is expected to be $20.5 billion, down from $23.4 in 2019.

MU stock - FCF margins

Source: Mark R. Hake, CFA

So, the second chart shows the history of Micron’s FCF margins. Over the past 10 years, when FCF was positive, Micron had FCF that came out to 15% of revenue.

That is the best estimate for where FCF will be in 2020. Now, here is where that is helpful. If revenue continues to ramp up in 2021, it will reach almost $25.7 billion, up from $20.5 billion in 2020.

As a result, that would bring FCF, using the 15% margin estimate, to $3.9 billion.

With Higher FCF, MU Stock Will Rise

The reason why this important is because FCF drives the value of MU stock. For example, the $2.38 billion estimate for FCF this year represents 4.1% of MU stock’s $57.9 billion market value.

Therefore, using that same method with the 2021 FCF estimate, the estimated value for MU stock is $104 billion. That works out to approximately $94 per share, or 80% higher than today’s price.

However, we need to discount that price to the present. Using a 5% present value discount over two years, the real value for MU stock is $94.3 billion. That works out to $85.14 per share or an upside of 63% from today’s price.

In conclusion, MU stock looks like it has hit a bottom. Analysts say the stock should be valued between $70 and $73 per share, up to 40% higher than today. A review of Micron’s FCF implies that MU stock could be worth as much as $85.14, or 63% higher.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review hereThe Guide focuses on high total yield value stocks. Subscribers get a two-week free trial.

Article printed from InvestorPlace Media, https://investorplace.com/2020/02/mu-stock-cyclical-bottom/.

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