Micron Still Searching For The New Normal

By Stephen D. Simpson, CFA | March 26, 2012 AAA

Commodity memory is an exceptionally volatile industry, and that's nothing new. That makes the concerns about Micron's (NYSE:MU) ASPs and weaker margins in the second quarter more or less par for the course. While it looks like the memory markets are on the road to recovery, investors have already seen a hefty rebound off the bottom and may want to ask themselves if they really need the turbulence and volatility that this stock is likely to produce in the coming year.

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Fiscal Second Quarter Earnings Bring Trade-Offs
Micron's earnings were a mix of good and bad news. Revenue performance (down 1% sequentially) was respectable, but investors may take a little issue with how that performance came about. Shipment growth was pretty strong, but ASPs were generally weaker than expected. While shipments (in bits) rose 21% in DRAM and 36% in NAND, prices fell 16 and 23%, respectively. The NOR business was also weak, as revenue fell 25% sequentially.

Although producing more chips is usually a good thing for semiconductor margins, mix shift appeared to work against Micron this quarter. So, despite the better-than-expected volume growth, gross margin fell more than a point and a half sequentially and came in below expectations. Operating performance was likewise unspectacular, as the company reported a $148 million operating loss for the quarter. (For related reading, see Analyzing Operating Margins.)

Guidance a Little Flabby
Micron management also didn't help matters with guidance. Although not much is really changing in terms of the 12-month picture, the company did guide for flat quarter-on-quarter pricing in DRAM. Given the expectations of ongoing recovery in consumer electronics demand and the Elpida bankruptcy, that's a bit surprising.

The company also noted that the delayed closing of its restructured NAND joint venture with Intel (Nasdaq:INTC) will push out some of the benefit. Over the longer term, though, this restructuring will give the company more of the JV's output and should be a positive for the company as memory market conditions improve.

What to Do About Elpida?
With Elpida now bankrupt, the question is what happens to those assets - principally the Hiroshima and Rexchip fabs. On one hand, capacity is valuable and whomever buys these fabs gets already-built capacity. On the other hand, the fabs are not exactly state of the art and the buyer is going to have to spend money bringing in new production equipment (and risk the attendant bottlenecks).

Micron may very well get involved, but probably should only make low-ball bids to do - say something on the order of $1 billion per fab. Should that take place, Micron would be just below Samsung in global memory share. As for Samsung, they could be a player as well, though the investments the company has made recently in new equipment may argue against it.

The other option is a slice-and-dice operation. I could see Taiwan Semiconductor (NYSE:TSM) wanting the Rexchip fab, but not the Hiroshima fab, while GlobalFoundries might be in the opposite position. Either way, I doubt that anybody is going to pay a premium for the Hiroshima DRAM fab assets, and Micron shares could get weak if they do appear to get pulled into a bidding war.

The Bottom Line
While I liked Micron as something of a call option on a tech recovery back in December at around $6, I'm not quite as enamored with it today.The chip and electronics recovery is proving to be a little less robust than hoped (or at least off to a slower start), and these shares have been pretty strong in the meantime. (or at least off to a slower start), and these shares have been pretty strong in the meantime.

Given that memory is a classic "whatever goes up, will come down" market, cash flow modeling is a bit dicey. While I'd probably be fine with holding Micron at a meaningful discount to book value or forward revenue, today's prices suggest there are better bets elsewhere in the chip space. (For related reading on book value, see How Return On Equity Can Help You Find Profitable Stocks.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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