Valuation And Pitch Of Micron Technology, Inc.
Nov. 27, 2017 5:02 AM • MU Summary There is an expected ROI of 22% or greater within a 6-month horizon. The DRAM and NAND industry indicates that MU can only grow. Micron is targeting the automobile industry with its DRAM products. By Nicholas Jackson, Lauren Noe, and Omar Nunez Micron Technology, Inc. (MU) Valuation Target: $55 Current price: $48.95 Company Background: Founded in 1978 in Boise, Idaho, Micron began as a semiconductor design consulting company. Today, Micron engages in designing semiconductor technologies and building memory. Specifically, Micron manufacturers DRAM, NAND, NOR, and 3D XPoint memory, which are used for USB Storage devices, both personal and server computers, memory cards, artificial intelligence, virtual reality, and autonomous cars. Micron is the fourth largest semiconductor supplier in the world with reported sales of ~$20.32 billion for FY’17, and recorded diluted FY’17 EPS of $4.41. Micron primarily operates through the following segments: Computer and Networking Business Unit, Storage Business Unit, Mobile Business Unit, and the Embedded Business Unit. The company primarily competes with Samsung Electronics Co. (OTC:SSNLF), Western Digital (NYSE:WDC), SK Hynix Inc. (OTC:HXSCF) and Toshiba Corporation (OTCPK:TOSYY). Why an investment opportunity exists today: Bullish Micron Technology has grown very rapidly and still has room to grow. Previously Micron could not sustain similar levels at the end of 2014 and it crashed from $35 to $11 just over a year later. We have little reason to believe this will happen again, as that was caused by too much supply coupled with too little demand in the PC market, which Micron has shifted away from. Micron Technology makes its money mainly from DRAM and NAND computer storage. These types of memory have been in high demand recently as mobile, server, and automotive demands for DRAM have been growing rapidly. Micron estimates that demand for DRAM will grow by 20% annually from 2016 to 2020. Micron will benefit greatly from this increased demand, as they make roughly two-thirds of their revenue from DRAM sales. DRAM As the demand for DRAM has declined in the PC market, Micron has shifted their focus away from the PC market and towards the server, mobile, and automotive markets. This shift puts Micron in a great position to capitalize on those growing markets. Two of Micron’s biggest customers for DRAM, Nvidia (NVDA) and Intel (INTC), are also focusing on the cloud computing and AI markets. The cloud computing market is expected to have a compounded annual growth rate (CAGR) of 19% by 2020. The AI market, which Micron is also growing into, is expected to have a CAGR of 50% from 2017 to 2021. The autonomous car market is expected to have a CAGR of 37% from 2017 to 2021. These growing markets that Micron is tapping into will prove lucrative for the company. As Micron has benefitted from increased demand in DRAM, they have also cut their costs of producing the DRAM by 17% from 2015-2016 and by 21% from 2016-2017. Although the gross margins cannot grow forever at this rate, they are still getting better and they will still be high for Micron. More importantly, Micron is not experiencing a large surplus of DRAM as it did a few years ago and recently DRAM demand has been higher than supply causing the price to increase and Micron to profit. NAND Similarly to the DRAM market, Micron and others in the industry predict a huge growth in NAND storage. Micron estimates demand for NAND storage to have a CAGR at 45%. This represents huge potential for Micron to invest in as the industry shifts towards 3D NAND architecture and away from planar architecture. 3D architecture allows more memory to be put on the same size wafer by stacking the transistors on top of each other allowing it to be more efficient and cost effective. Micron also estimates that they will have a decrease in cost to produce 3D NAND memory by up to 30% annually. This is coming as Micron is shifting their production to focus on producing 3D NAND memory rather than planar memory. Micron has converted around 75% of its NAND output to focus on 3D NAND while the total demand for 3D NAND products is only around 50%. This positions Micron to be a more dominant player in the 3D NAND industry going forward as that will be their main focus. This will allow them to reduce costs year after year and be a leader in developing new technology. Drivers for increased demand for Micron’s products Autonomous driving is in its infancy right now and Micron has become an industry leader in supplying much of the hardware necessary for the car’s AI to function properly. Right now, Micron occupies about half of that market and it is only expected to grow. Currently, autonomous car manufacturers use Nvidia GPUs to power the AI they are developing. Each unit requires multiple high-end graphics cards with a hefty amount of DRAM, which Micron supplies. Currently, the driver assistance features in high-tech cars require 2-4 GBs of DRAM and by the time fully autonomous or nearly autonomous cars are released, the demand will skyrocket up to 25 GBs of DRAM. It is expected that self-driving cars will have an effect on our lives by the early 2020s. This rapid growth in such a short time poses a great opportunity for Micron. Why Micron won’t crash again Just a few years ago, Micron suffered huge losses as they drastically overestimated the demand for DRAM, their largest source of revenue. This prediction was industry-wide and other DRAM manufacturers also suffered during that time. Now Micron and other industry leaders are being more careful. They are not building new plants to raise production of DRAM to meet the rising demand, instead they are getting better at producing with what they already have. Demand for DRAM is expected to outpace supply by about 1-2% each year for the next few years. This slight shortage ensures that Micron will sell all of the DRAM they make and they will be able to sell it at higher prices. Investors are wise to approach Micron tentatively especially if they got burned during the crash just a few years ago. However, there is not much evidence this will happen again and if it does happen, it will be nowhere near as drastic as last time. Why Micron is undervalued It’s hard to say a stock that is up over 150% in the past year is undervalued but Micron is one of those cases. Since Micron had such a tremendous crash just a few years ago, investors are hesitant to buy Micron enough to drive up prices to where it should be. Micron has a P/E ratio at around 10, which is dramatically lower than its larger competitors. The industry average is around 30, meaning if Micron would just grow enough to meet the average, it would triple Micron’s value. More importantly is Micron’s forward P/E of about 7. This is lower than Micron’s current P/E and significantly lower that the S&P 500 average at about 20. Micron is clearly undervalued compared to its competitors and has a lot of room to grow. While it does have its risks, the upside is much greater and it is a great investment. Bearish From 2013-2015, micron stock shot up from $5 to $35. It subsequently collapsed back to $10 because Micron initially did a poor job of integrating an acquisition, leaving them in a difficult position competitively against their peers. Additionally, a weaker than expected PC demand, pricing pressures, and a boost in capacity from Samsung Electronics sent Micron’s earnings into a tailspin. The cyclical industry will push Micron to not lose its footing. China wants to build its own domestic semiconductor market for two reasons – concerns about the security of the U.S. tech, and the need to boost its economic growth. In 2016, Chinese state-backed conglomerate Tsinghua Group tried to buy Micron and a 15% stake in Western Digital. However, both deals were eventually terminated due to U.S. Security concerns. Nonetheless, the Chinese government and Tsinghua are still aggressively developing their own semiconductors across multiple industries – which means that it could eventually flood the market with cheap memory chips and bury smaller players like Micron. During a recent event in Taipei promoting the merger of Micron and Intel, Micron CEO Mark Durcan warned that if China spends “the money that they say they are capable of spending, they can create oversupply.” He noted that the move was “absolutely” a concern for the entire industry. With roughly 60% of its sales coming from the dynamic random-access memory chips, or DRAM, Micron’s financial performance tends to ebb and flow with the condition of the broader memory market. Micron’s share price performance in 2016 speaks to the dynamic that Micron lacks a meaningful economic moat. The same cannot be said for Samsung, whose product diversification has a protective effect. Micron carries a heavy debt load. The company has around $9.15 billion in long-term debt. It is unclear why Micron’s management has decided to rely on debt instead of equity and retained earnings to fund operations. But this leverage will makes Micron’s stock price volatile. Price Target: $55 Our price target for Micron Technology is $55. This represents a 22% return on investment within a year. We came to this number because the industries Micron is involved with are growing at anywhere from 20-50% year over year. This means that even if Micron’s stock does not get any more expensive and it just tracks the revenue increases from the growing industries, it will easily reach this target. However, if Micron increases in value just based on it being undervalued now, it has the ability to hit the price target without much growth at all from its core businesses. As long as Micron keeps putting out great numbers and doesn’t suffer from an unexpected oversupply of its products, it will prove to be a great investment. Financials Below are Micron’s income statement, cash flows, operating cash flows, base key assumptions, and balance sheet. Income Statement/Cash Flows ￼ Image Source: Lauren Noe, 2017 ￼ Image Source: Lauren Noe, 2017 Micron is not in the stablest financial position with a debt load of $2500 mm and $275 mm in cash on hand. EBIT margins have increased from 2.6% in 2013 to 28.88% in 2017. We expect EBIT margins to increase to the 40%-50% range over the next five years with the expected reductions in operating expenses. Base Case ￼Image Source: Lauren Noe, 2017 Using a DCF model, our base case is calculated based off what amount of earnings will be required in order to justify the current stock price. We forecast a revenue CAGR of 20%. Operating expenses are expected to decrease in the coming years, expanding operating margins to 26% by 2021. Net income grows at a CAGR of 20% as a result of expanding operating margins and maintaining an effective tax rate of 4.5%. Balance Sheet ￼ Image Source: Omar Nuñez, 2017 Micron’s projected 4-year balance sheet indicates steady and continual growth. The calculations are based on average growth rates from a historical 4-year period. Forecasting retained earnings (under owner’s equity) was a challenge, since many years were left unreported in this specific area. This caused anomalies when projecting based on average growth rates. Conclusion Micron’s current price doesn’t reflect its true valuation and potential growth margins. Although our estimations dictate that a price target of $55 over a 6-month horizon is very likely, the current up-trending market could surely lead to unprecedented growth past the price goal. Further, with Micron aiming to implement its DRAM and NAND technologies into the automobile industry, we can expect exponential growth in the near future. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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: This article was written for 2017 Seeking Alpha Stock Pitch Competition by Nicholas Jackson, Lauren Noe, and Omar Nunez.