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Micron Enjoying A Break In The Clouds
How do you evaluate a nice property in a very tough neighborhood? That is the ever-present challenge for investors considering American memory chip maker Micron (NYSE:MU).
As investors have seen over and over again, no company can overpower the strong cyclical currents in the commodity chip market for very long. The key, then, lies in anticipating the changing tides and abandoning a classical "buy and hold" strategy in favor of "buy, sell, and maybe buy again later".
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The Quarter That Was
Helped by a rebound in demand for consumer electronics, Micron saw a solid fiscal third quarter. Revenue rose 17% on a sequential basis to just under $2.3 billion (ahead of estimates) and more than doubled from the year-ago level. It is not often that you see that sort of growth in companies with billions of dollars in revenue, but then that is the nature of cyclical industries.
Margins were likewise strong for the quarter. Gross margin rose to about 35% on an adjusted basis, and the company's reported operating income grew more than a quarter from the second quarter and reversed a year-ago loss. All in all, Micron delivered its third straight profitable straight years of losses.
The Rubber Band Is Stretching ... For Now
I suppose you can think of the DRAM and NAND markets like rubber bands - demand sucks up available capacity and prices begin rising (the band stretches). Eventually, though, companies pile on additional capacity, remove the tension from the band, and cause it to snap back. If wrists happen to be in the way during that snap back, there is definitely some pain involved.
Right now, it is a good time for the memory chip market. Devices like Apple's (Nasdaq:AAPL) iPhone and iPad, Research In Motion's (Nasdaq:RIMM) smartphones and Hewlett-Packard's (NYSE:HPQ) computers are demanding more and more memory with every edition. In the meantime, the severe downturn in the market over the past few years had companies mothballing production lines and shelving expansion plans. This, in turn, is a part of how Micron realized a 9% sequential increase in DRAM prices - though NAND pricing did decline about 4%.
Make Hay While You Can
It takes time for the chip industry to respond to better prices with more capacity, so it looks like investors might be able to enjoy a couple years of good revenue growth in the space before the inevitable peak. Micron's stock has already bounced strongly off its lows, but the valuation and past behavior suggest there is still room for more gains.
At the same time, investors should cast a wider net if they want to play this rebound. Micron's rival SanDisk (Nasdaq:SNDK) has a lot to offer as well, including a higher valuation and stronger rebound over the past year. Investors who are comfortable going farther afield should also look at the Korean memory-makers Hynix and Samsung. Last and not least, chip equipment companies like Applied Materials (Nasdaq:AMAT) and KLA-Tencor (Nasdaq:KLAC) could be worth a look as well; they are not direct plays on memory per se, but an overall recovery in the chip sector will ultimately spur demand for more equipment.
Bottom Line
Investors need to approach this stock and this sector with some caution. Too often I have heard the siren call of "but it is different this time" on TV, but the inherent cyclicality of the sector just does not change. There is no question that nimble investors can make money in this sector, but this is a party where the price of over-staying your welcome can be painful indeed. (For further reading, see Great Company Or Growing Industry?)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
As investors have seen over and over again, no company can overpower the strong cyclical currents in the commodity chip market for very long. The key, then, lies in anticipating the changing tides and abandoning a classical "buy and hold" strategy in favor of "buy, sell, and maybe buy again later".
IN PICTURES: 20 Tools For Building Up Your Portfolio
The Quarter That Was
Helped by a rebound in demand for consumer electronics, Micron saw a solid fiscal third quarter. Revenue rose 17% on a sequential basis to just under $2.3 billion (ahead of estimates) and more than doubled from the year-ago level. It is not often that you see that sort of growth in companies with billions of dollars in revenue, but then that is the nature of cyclical industries.
Margins were likewise strong for the quarter. Gross margin rose to about 35% on an adjusted basis, and the company's reported operating income grew more than a quarter from the second quarter and reversed a year-ago loss. All in all, Micron delivered its third straight profitable straight years of losses.
I suppose you can think of the DRAM and NAND markets like rubber bands - demand sucks up available capacity and prices begin rising (the band stretches). Eventually, though, companies pile on additional capacity, remove the tension from the band, and cause it to snap back. If wrists happen to be in the way during that snap back, there is definitely some pain involved.
Right now, it is a good time for the memory chip market. Devices like Apple's (Nasdaq:AAPL) iPhone and iPad, Research In Motion's (Nasdaq:RIMM) smartphones and Hewlett-Packard's (NYSE:HPQ) computers are demanding more and more memory with every edition. In the meantime, the severe downturn in the market over the past few years had companies mothballing production lines and shelving expansion plans. This, in turn, is a part of how Micron realized a 9% sequential increase in DRAM prices - though NAND pricing did decline about 4%.
Make Hay While You Can
It takes time for the chip industry to respond to better prices with more capacity, so it looks like investors might be able to enjoy a couple years of good revenue growth in the space before the inevitable peak. Micron's stock has already bounced strongly off its lows, but the valuation and past behavior suggest there is still room for more gains.
At the same time, investors should cast a wider net if they want to play this rebound. Micron's rival SanDisk (Nasdaq:SNDK) has a lot to offer as well, including a higher valuation and stronger rebound over the past year. Investors who are comfortable going farther afield should also look at the Korean memory-makers Hynix and Samsung. Last and not least, chip equipment companies like Applied Materials (Nasdaq:AMAT) and KLA-Tencor (Nasdaq:KLAC) could be worth a look as well; they are not direct plays on memory per se, but an overall recovery in the chip sector will ultimately spur demand for more equipment.
Bottom Line
Investors need to approach this stock and this sector with some caution. Too often I have heard the siren call of "but it is different this time" on TV, but the inherent cyclicality of the sector just does not change. There is no question that nimble investors can make money in this sector, but this is a party where the price of over-staying your welcome can be painful indeed. (For further reading, see Great Company Or Growing Industry?)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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