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Micron Technology (MU), as one of the leading players in the semiconductor industry, has seen an impressive run in their share price with returns of 87.6% for 2017 and 29.5% for 2018 YTD, according to data from Bloomberg. However, their share price has been extremely volatile over the past six months, hovering around the $50-$62 range, struggling to break through its 52-week high ($64.66).
This is despite the high price targets set for Micron that have been continuously reiterated or upgraded by most analysts throughout the year. The current mean price target stands at $83.29, implying a 56.5% upside.
To access the reliability of the price targets, I valued Micron myself using valuation models and assessed their fundamentals. Following that, I examined their share price movement over the past year to identify the factors and risks pertaining to them.
I believe discounted cash flow analysis is the best method in valuing Micron given Micron’s steadily increasing cash flows, strong revenue growth and the absence of dividend payments. I then corroborated the figure by comparing it with the comparable company valuation.
I used free cash flows to the firm to value Micron with a five-year time horizon. Below are the key assumptions used:
- Forecast Period: I used conservative estimates in projecting future financials despite bullish estimates for earnings growth. FY18 revenue was based on annualized figures of Micron’s Q1-Q3FY18 earnings. I assumed decreasing revenue growth rates for future years of 3.5%, 2.8%, 2.5% and ending with a sustainable growth rate of 2%. Gross margins of 58% were based on current annualised figures from Q1-Q3FY18 and assumed they are constant for future years. Debt repayment for FY18 includes another $2 billion reduction in Q4 based on company guidance, for a total $4 billion. $10 billion in share repurchases are included from FY19 as part of Micron’s announced strategy. Source: Author's Financial Models
- Terminal Value: I used an average figure obtained from both the perpetual growth and EV/EBITDA valuation multiple approaches. I assumed a perpetual growth rate of 2% and used Micron’s EV/EBITDA of 6.9x (71% below industry average). Source: Author's Financial Models
- Discount Rate: I derived the 8.8% discount rate based on the firm’s weighted average cost of capital. Cost of equity was computed using capital asset pricing model (CAPM) with a one-year levered beta of 1.55, risk free rate of 2.87% based on the 10-year US Treasury rate, and equity risk premium of 4.4% obtained from National Bureau of Economic Research based on expected 10-year S&P 500 return relative to the 10-year U.S. Treasury bond yield. Yield on debt of 5.3% was based on the interest rate of Micron Technology bonds (maturity 01/08/23) – this corresponds exactly to Micron’s actual interest expense as a pecent of long-term liabilities in FY17 and FY18 YTD.
Source: Author's Financial Models
Comparable Company Valuation
I used the average of six different metrics (EV/sales, EV/EBITDA, EV/EBIT, P/E, P/S, P/B) in determining the relative valuation of Micron’s share price compared to the industry. Industry multiples were obtained from the NYU Stern School of Business database which was based on 72 profitable public companies in the US semiconductor industry. I found Micron was trading at a discount in all metrics used.
Source: Author's Financial Models
DCF analysis generated the intrinsic value of Micron’s share price at $97.85. My figure is higher than the mean price target of analysts of $83.29 despite using conservative assumptions. Reasons for this may include:
a) Higher capital expenditures for future years used by analysts (likely as semiconductor companies ramp up their production processes) and/or
b) Lower depreciation expenses for future years used by analysts (unlikely as the figures I used based on percent of PP&E were already lower then the previous 5 years) and/or
c) WACC for future years was adjusted based on company guidance regarding its debt and equity levels (very unlikely as it would result in an even higher valuation).
In any case, my valuation is in line with the relative valuation of Micron to its peers of $95.66 and also below the high price target of $120 by analysts.
With the valuation figures obtained, I then looked at Micron’s fundamentals to assess if there were any areas of concern that might negatively impact their future financial performance. The main areas I evaluated were revenue, earnings, capital structure and product development.
- Revenue: Micron’s revenue increased significantly in FY17 by 63.9%, overtaking Broadcom (AVGO) and Qualcomm (QCOM), which made them the second-largest US semiconductor supplier behind Intel (INTC) and the fourth-largest globally. Their global share of revenue for 2017 was 5.3%. Their revenue growth for 2018 as of Q3 was 45.8% Y/Y. With the onset of the fourth wave of technology (autonomous vehicles, smart devices, super computers, data providers), I expect them to take full advantage of their position by rapidly scaling production.
- Earnings: Micron has reported positive earning surprises (>2% vs Mean EPS) for 11 of the last 12 quarters. Gross margins rose 2.5% Q/Q and stands at 60% for Q1-Q3FY18 vs 41.5% in FY17. As Micron’s gross margins have been higher than the industry average for the last five years, I see no reason it will decrease in the next few years. Source: Micron Investor Relations
- Capital Structure: Micron has managed to pay down $2 billion in debt during Q3, achieving a positive cash balance. They expect to reduce debt by another $2 billion in Q4. This move now brings their debt levels in line with their peers and also sets them in a good position to acquire smaller chip makers. Given their high gross margins and the high economies of scale of the industry, Micron would be able to quickly realize synergies from strategic acquisitions as they did with the Inotera acquisition at the start of FY17. Micron also announced a share repurchase program of up to $10 billion commencing in FY19. This strategy as quoted by CEO of the company, Sanjay Mehrotra, is part of their "ongoing commitment to enhancing shareholder value." Apart from sending positive signals to the market, I expect this strategy to also have a positive impact on their share price through the change in their capital structure, as Micron have a high cost of equity at 9.7%. Source: Micron Investor Relations
- Product Development: The complexities in producing memory products include not only achieving mass volume productions to meet demand but also achieving output crossovers for profitability and continuous innovation in keeping up with competition in this saturated market. Micron announced DRAM one-year production shipments and 96-layer 3D NAND production shipments are set for the second half of 2018. Their production began around six months later than Samsung (OTC:SSNLF), which was the first developer, but Micron is currently the leading innovator for the new generation of 96-layer 3D NAND with Samsung close behind. Micron also announced that development of 1Z and 1-alpha technologies for DRAM already are underway. Considering that Micron is a high-volume manufacturer, it is impressive that Micron expects to reach bit crossover of 1X and 64-layer this year. During the Q3 earnings call, the CFO of Micron, Dave Zinsner, also mentioned Micron are "expecting 3D XPoint products toward the end of calendar year 2019" which is regarded as a revolutionary innovation in memory products. This points to me the speed of their production capabilities. If they are able to hit their bit production targets, they will have a significant first mover advantage in capturing demand for the new generation of memory products.
From the fundamentals, I only see positives going into Micron’s future. The share price however has been very volatile in recent months. According to data from Reuters, Micron’s beta against the S&P 500 is 1.82, and their share price has been more volatile than 97% of S&P 500 firms in the past 150 days.
To try to understand the large swings and volatility in prices, I examined Micron’s one-year share price movement to identify the market risks that might concern them.
Bulls vs. Bears
Firstly, there was some speculation that Micron's price was being influenced by short sellers utilizing Micron as a potential short opportunity in the event of adverse market conditions. This issue has already been covered and concluded as unlikely by other contributors (Business Quant and Kwan-Chen Ma). Looking at Micron’s current percentage of short float to shares outstanding which stands at around 4.45% ($2.74 billion), I find that this figure is indeed higher than the semiconductor industry average. However, it's still reasonable for a large-cap stock (Micron’s market capitalisation is $61.7 billion) and I concur that it would not materially keep the price down.
What I did notice was that the percent short float figure also was volatile and resembled the movement of Micron's share price as seen in the price chart below. This indicates to me that investors are highly sensitive to Micron's market price movement and might perceive them as a momentum stock without considering their underlying value.
What's interesting is that the percent short float figure has been in a decreasing trend over the past couple of months, reaching a one-year low. This might be a signal of a decreasing fear in the share's volatility.
Technicals vs. Fundamentals
Although technical analysis should not be given weight for the long-term value of a company, it's important to note how Micron’s share price has been moving. Micron’s returns for one-year (87.6%), six months (28.9%) and one month (2.2%) are indeed impressive. However, Micron has struggled to reach their high price target with an apparent resistance level around the $63 mark. On closer examination, the drops can be correlated to certain trigger events as well as the S&P 500 index movement. The latter was earlier identified with Micron’s high beta against the S&P 500 of 1.82. Aside from S&P 500 index related price swings, the following events caused large price drops:
- Nov 25: US tax reform leading to reshuffling of equity sectors with the biggest outflows coming from the technology industry.
- Mar 15: Facebook price drop of -17% (due to data breach involving Cambridge Analytica) dragging the entire technology sector down.
- Apr 5: Micron initiated by UBS with a sell rating (They have since upgraded to a $60 price target).
- Jun 4: Micron chip sales banned in China.
- Jun 20: EU announces tariffs against the US.
- Jul 16: Netflix price drop of -14% (missed subscriber expectations) dragging the entire technology sector down.
- Jul 26: Facebook price drop of -19% (after announcing slow future growth expectations) dragging the entire technology sector down.
Based on these events, I found Micron's price also very sensitive to the technology sector index and negative macroeconomic events.
US vs. Global
To interpret why these events caused very high price movements in the semiconductor industry, particularly Micron, we have to understand the industry landscape. The semiconductor industry is a global race for corporations as well as countries. Because of the rapidly growing demand, the industry is attractive to new entrants, making it highly competitive. The high margins also make it accretive for consolidation among existing competitors.
Despite the US being the global leader in the industry, the company is quickly being outpaced by other countries such as South Korea, Taiwan, EU and China. The top 15 largest semiconductor companies are currently represented by six different countries. On top of that, China has raised $47 billion in funding as part of their Integrated Circuit Industry Development to develop their semiconductor industry with a goal of becoming the global leader in all segments of the semiconductor supply chain by 2030.
Revenues in the industry are highly dependent on the average selling price which is influenced by changing supply and demand. As seen in the market during 2015-16, drops in ASP impacted even large companies such as Micron. Their revenue declined in both 2015 (-1%) and 2016 (-23.4%).
Aside from competition, trade tensions have increased the systematic risk of the overall stock market, causing an increase in volatility. Although current tariffs imposed by the U.S. or China do not directly affect the semiconductor industry, rising trade tensions have specifically impacted Micron. On July 3, Chinese government-backed semiconductor firm UMC filed an alleged patent infringement lawsuit against Micron, which resulted in China temporarily banning Micron’s chip sales, causing the share price to drop 5%. I do not see this as a big concern in the long run as Micron confirmed the ban will only impact less than 1% of revenue. Nonetheless, understanding the economics of the industry and global landscape has shed some light on Micron's high price sensitivity.
It's important to point out that technical analysis should only be used as an indication and in conjunction with fundamental analysis. Based on technical analysis, the downtrends over the past six months have been decreasing in size and are followed by larger uptrends. As the current downtrend has bottomed and is holding strong at the $52 support level with a percent of short float to shares outstanding at a record low, there's a high indication that a huge surge in the share price will occur soon.
Price Target (12 month)
- Valuation: Reinforced by Micron’s strong fundamentals, I hold that my DCF valuation of $97.85 is very appropriate based on the conservative assumptions I used. It's further supported by Micron’s relative valuation to its peers of $95.66.
- Competition: The company’s strong position globally and its efforts as the leading innovators of NAND/DRAM memory products will enable them to increase their revenue share in those areas. However, there's rapidly increasing competition and consolidation within the industry that might pose a threat to them in the future.
- Volatility: I found Micron’s share price to be extremely volatile and very sensitive to market and economic-related news. Their price also is highly correlated to the technology sector and S&P 500 index, and was more volatile than 97% of the S&P 500 companies.
- Buy opportunity: Despite the volatility, technical analysis indicates a strong uptrend for Micron’s share price with strong support levels at the current price. The company also is relatively undervalued among their peers.
- Call: Overall, bearing short-term price fluctuations, this is an amazing value stock to hold and is currently trading at a significant discount.
Disclosure: I am/we are long MU.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: No information in this publication is intended as investment, tax, accounting, or legal advice, as an offer or solicitation of an offer to sell or buy. Material provided in this publication is for educational purposes only, and was prepared from sources and data believed to be reliable, but I do not guarantee its accuracy or completeness.