The Craziness Is Well Underway Again At Micron

By Stephen D. Simpson, CFA | June 20, 2013 AAA

As someone who has almost always had a semiconductor stock in his portfolio, I can tell you that you have to a have a loose screw or two to like this sector. But the memory chip space is a completely different wing of the semiconductor asylum, one where the peak-to-trough cyclicality is truly impressive and where long-term economic returns are difficult to earn.

That has led to a pretty “challenged” existence for Micron (NYSE:MU), and a stock that has been all over the map. With the industry consolidating down to just four major suppliers, though, the thought now is that the players will operate on a more rational basis and allow each other to actually book some respectable earnings and cash flow. While I think Micron's shares have room left to run on investor enthusiasm, it's tough to outline a fundamental case where the stock is significantly undervalued for the long term.

Conditions Continue To Improve
With memory chip supply a great deal more rational recently, Micron is continuing to enjoy significantly improving financials.

Revenue rose almost 12% from the prior quarter (and rose 7% from last year's level). NAND revenue improved 7% sequentially, with roughly flat volume growth and an ASP improvement of 8%, while DRAM revenue jumped 23% on 6% volume (bit) growth and 16% higher pricing. NOR was basically flat for the quarter.

With strong pricing and improving volume, Micron is seeing better utilization and much better margins. Cost-per-bit was down 1% sequentially for NAND and 5% for DRAM, helping gross margin rise more than six points from the fiscal second quarter and more than 13 points from the year-ago quarter. This is also flowing down to the operating line, where the company reversed year-ago and quarter-ago losses and logged an operating margin in excess of 6%.

SEE: A Look At Corporate Profit Margins

Elpida Will Change A Lot
It has taken a while to navigate all of the legal processes, but it looks like Micron is on target to close the Elpida acquisition in the next quarter. Bringing this bankrupt Japanese memory maker into Micron will not only significantly improve the company's capacity, but it will particularly add to Micron's mDRAM capacity. mDRAM is currently a small part of Micron's revenue, but a growing section of the market and Apple (Nasdaq:AAPL) already uses about 80% of Elpida's mDRAM capacity.

Those aren't the only benefits to the deal. With the deal done, there will effectively be just three DRAM suppliers, and that should encourage more rational competition and investment decisions. Micron may also benefit from economic policies, as the movements in the yen have made the cost basis of Elpida much more interesting since the entire transaction process began.

The Only Constant Is Change
Micron has been seeing some positive trends in its capex – the company's capex investment per wafer has recently been running around $400, half the rate back in 2005. Keep in mind, though, that although the trend has been pointing to lower capex-per-wafer, there have been a lot of ups and downs along that trend line. What's more, while working with Intel (Nasdaq:INTC) on 3D NAND should give Micron access to high-end technology at a reasonable price, transitions in this sector have always been turbulent.

SEE: 3 ETFs To Play The Semiconductor Rally

Moreover, just because the industry is playing nice today, I won't assume there has been a permanent change. Hynix and SanDisk (Nasdaq:SNDK) have good reason to be rational, but Samsung operates a very different type of business and what's rational for Hynix and SanDisk in NAND may not seem as rational to Samsung (and vice versa).

The Bottom Line
If you believe you can accurately model Micron's cash flows beyond the next year or two, I salute you. Given the extreme year-to-year volatility, I don't really put much faith in that process for this stock. That leaves investors with less appealing metrics like EV/EBTIDA, EV/sales, and tangible book value. By those metrics Micron looks pretty well-valued, although not yet at peak prices. All told, investor enthusiasm could still take these shares into the high teens without breaking any records. That's appealing potential from today's price, but these shares carry above average risk and are really only suitable for the more stout-hearted investor.

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