The broad investment thesis on cyclical memory chipmaker Micron (NASDAQ:MU) isn’t all that complicated. Buy MU stock when the music is playing and times are good (the up cycle, or when demand outstrips supply, and revenues, margins, and profits are all rising). Sell MU stock when the music stops playing and times are bad (the down cycle, or when supply outstrips demand, and revenues, margins, and profits are all dropping).

Micron reported first-quarter numbers on Tuesday Dec 18 that underscored that the music has stopped playing for MU stock. Revenue growth is slowing. DRAM and NAND chip prices are falling. Shipment volume growth is decelerating. Margins are compressing. Profit growth is slowing.

Worse yet, MU’s Q2 guide implied that these negative trends will only get worse. Revenue growth is expected to go negative next quarter. Chip prices are expected to keep falling due to oversupply. Demand is expected to weaken due to inventory adjustments and trade war headwinds. Margins are expected to drop way more than they did in the first quarter. And, profits are expected to drop.

Overall, the writing is on the wall. The music has stopped playing for MU stock. Because of this, MU stock is a tough buy here and now.

Contrarian investors will say that the time to buy MU stock is when the music stops playing. There’s some truth to that. The stock always tends to bottom before margins do.

But, margins are just starting to reverse course. Usually, these compression trends last several quarters. Moreover, so long as margins are falling, there’s simply a lot of risk in owning MU stock. As such, before buying into this name, the best thing to do is wait for gross margins to stabilize.

Until that happens, avoid MU stock.

Things Are Much Worse Than Expected

Broadly speaking, Micron’s Q1 earnings report, conference call, and Q2 guide affirmed that things in the memory market are much worse than most expected.

The consensus thesis heading into the report was that memory chip supply was building. But, that build was largely being offset by secular demand drivers from robust growth markets like data-centers and AI. Thus, revenues, gross margins, and profits would all fall, but not by much.

This isn’t the case.

Instead, the company’s secular demand drivers are weakening in the near term due to trade war turbulence. This weakening demand is coming at a time when the memory chip market is already oversupplied. As such, revenues, gross margins, and profits are all dropping by a bunch.

Next quarter, revenues are expected at $6 billion. The consensus estimate was $7.3 billion, which would’ve been roughly flat year-over-year. Instead, revenues are expected to drop almost 20%.

Gross margins are expected in the low 50’s. This marks the second consecutive quarter of sequential compression. The declines are getting worse. In Q1, gross margins compressed 240 basis points. Next quarter, they are expected to compress more than 700 basis points.

Meanwhile, EPS is expected at $1.75. The Street was looking for $2.44. In the year ago quarter, EPS was $2.82. Thus, not only did the guide miss the mark, but it points to a 38% year-over-year drop, as well.

Overall, Micron’s first quarter earnings report confirmed that the music has stopped playing for MU stock. The bad times are here. The oversupply problems are hitting hard. And, the stock will remain weaker for longer.

Wait For Gross Margins To Turn Around

MU stock initially dropped about 10% in response to the rough Q1 report. However, it was attempting to claw its way back before being hit by the broader market weakness.  As of this writing, MU stock is down about 15% after the earnings report (vs. the S&P 500’s 7.6% decline in the same period).

So why did Micron stock recover at all? Because MU stock was already priced for this disaster report and sharp earnings erosion. Estimates will move down following the report. But, even if they get chopped substantially, this stock will still be trading at a single digit forward earnings multiple. That is just way too cheap to warrant much further downside in the stock.

As such, there is a strong argument that because MU stock is so cheap, it is already priced for disaster, so as disaster happens over the next few quarters, the stock could be resilient.

That being said, the smartest thing to do here is wait for confirmation that the music will start playing again for Micron. That confirmation will come on the gross margin line. As soon as gross margins stabilize quarter-over-quarter, that implies that the underlying supply-demand situation is improving. When that happens, it’ll be time to buy MU stock.

Until then, while downside seems limited, so does upside. As such, investors should wait for gross margin stabilization before buying into MU stock.

Bottom Line on MU Stock

The first quarter earnings report confirmed that the music has stopped playing for MU stock. The music won’t start playing again until gross margins show signs of stabilizing. Until then, MU stock is best avoided.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.