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Micron (MU): A Potential Long-Term Compounder

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Micron (MU)

  • Price:  $49.16
  • Sector:  Technology
  • Industry:  Semiconductors

Click here to skip the details and go straight to the intrinsic value calculation for Micron.

Investment thesis

     When you look at today’s digital world full of information, what do you see?  I see data.  It’s everywhere.  You create 1.7 megabytes of data per second.  Internet users generate about 2.5 quintillion bytes of data each day.  Data is considered the new oil.  90% of the world’s data has been produced in just the last two years.  

     There’s a nearly incalculable amount of data being created daily and it’s exponentially increasing as more people get connected to the internet.  All that data needs to be stored somewhere.  This is where Micron comes in.  Micron produces memory chips and is one of three companies that dominate this market.  The others are Korea-based SK Hynix and Samsung.  The memory market is therefore an oligopoly, with only three companies accounting for almost all market share. 

     Micron holds about a 21% share for DRAM and is the only one of the three based in the US.  In NAND, in which there are more competitors, Micron holds about a 13% share.  The market for memory solutions is increasing.  Micron has a good share of the pie, and the pie is growing yearly.  Everyone will be able to share the spoils.

     Memory chip makers such as Micron are distinct from chip processor manufacturers such as Intel or NVIDIA.  At a risk of stating the obvious, just understand that Micron develops storage for data, while companies like Intel create the chips that take that data from the memory and process it in all sorts of different ways, such as performing calculations or rendering graphics for a video game.

     The fact that Micron is completely reliant on sales of memory, (as opposed to Samsung or Intel, which are larger conglomerates that could subsidize losses from their memory business from other divisions), could actually be an advantage to Micron.  It means that they have to be at the forefront of memory technology, providing the best in-class products, and being able to lower costs as much as possible in downturns.

     Micron has several secular tailwinds that are occurring and will continue to occur over the next ten years.  This will make Micron a great stock to own if you’re looking to compound your capital.  The emerging, disruptive trends that will create huge demand for Micron’s memory and storage products include the following:   Adoption of 5G, artificial intelligence, machine learning, autonomous vehicles, Internet-of-Things, gaming, continued growth in cloud computing, and more advanced mobile devices that require more memory storage.

     Today’s data is the new business currency and more advanced techniques to collect, store, and manage data with speed and efficiency will be required.  Micron, with it’s great management and superior technology, is in a unique position to benefit from a data-driven world.

     Whenever you’re considering an investment in a stock, always ask yourself, will this company be around in 10 years still doing the same thing?  Also ask, does this company have a long runway for growth and is its total addressable market (TAM) increasing?   With Micron, the answer to these questions is yes.  

     As investors, we need to be humble enough to admit we can’t predict the future.  However, a small amount of forecasting is required when picking investments.   What can we predict with a fair amount of certainty?  Well, we can reasonably be certain that the future will be more digital, more people will be connected to the internet, artificial intelligence (AI) will play a more prevalent role in the economy, and much more data will be generated.  Micron is poised to take advantage of this trend.

     Now, just because a company fits the above standards, before you consider investing, you have to decide whether the stock is undervalued, fairly-priced, or overvalued.  Just because a company is great doesn’t mean it’s a great investment.  With Micron, fortunately, the stock is very undervalued.  This is rare in today’s market, with the S&P 500 close to all-time highs. 

     I hope to demonstrate in this article that Micron is a high-quality undervalued stock that should be considered further as an addition to your portfolio.  We’ll do an overview of Micron and its industry, analyze some financial metrics and do a discounted cash flow valuation, then discuss some potential risks. 

Company & Industry Overview

     In 2017, the Economist claimed that data replaced oil as the world’s most valuable commodity.  Micron makes memory and storage devices that are able to store this data.  Specifically, they make DRAM and NAND storage products.  DRAM or dynamic random access memory devices provide high-speed data retrieval with low-latency.  DRAM products lose content when a device is turned off (“volatile”).  They are used in markets such as smart-phone, cloud server, enterprise, industrial, automotive, and others.  NAND devices are “non-volatile”, re-writable semiconductors in which the memory contents are not erased when a device is turned off.  These are used in smart-phones, networking products, cloud, removable storage, and various other consumer markets. 

     Without getting into too much detail, all you have to know is that DRAM is short-term memory that’s fast but the contents erase once a power source isn’t connected whereas NAND is long-term storage memory that’s slower but retains its contents even if power isn’t connected. 

     Micron also sells their own proprietary type of storage called 3D Xpoint technology which is a class of non-volatile storage that’s a hybrid between DRAM and NAND offering higher capacity and non-volatility over DRAM along with lower latency and higher endurance as compared to NAND.  Approximately 66% of Micron’s revenue comes from DRAM products and 31% comes from NAND products.  Micron is the only one of the big three memory producers based in the US.  

     Let’s take a look at Micron’s stock price performance as compared to the S&P 500 and to the Philadelphia semiconductor index.

         Source:  Yahoo Finance

     As we can see, Micron outperformed the S&P 500 by a good deal over the last ten years, returning about 560% as compared to the S&P 500’s 230%.  Also, we note that Micron’s stock has for the most part followed the semiconductor’s index upward trend which isn’t surprising.

     The memory and storage markets are considered to be commodity markets.  This means that like oil or natural gas, the prices of these products fluctuate according to supply and demand and the products are generally uniform or homogenous.  Therefore, the price is mostly the same among all producers. 

     Commodities such as natural gas, lumber, and oil have their prices set by market supply and demand forces.  So too does memory.  Memory prices have their peaks and troughs just like other commodities and therefore the stock price of memory companies like Micron will usually follow these peaks and troughs.

     However, I’d like to argue that Micron distinguishes itself with its proprietary leading-edge technology and may become less of a commodity-type stock in the future than investors believe it to be.  One of the reasons comes from the following recent news in its partnership with NVIDIA in developing a new graphics memory solution.  Micron has patented this and is the sole producer.

From Micron’s investor relations webpage:

September 1, 2020

“Micron Technology, Inc. (Nasdaq: MU), today announced the world’s fastest discrete graphics memory solution, GDDR6X, the first to power system bandwidth up to 1 terabyte per second (TB/s). 

Working with visual computing technology leader NVIDIA, Micron debuted GDDR6X in the new NVIDIA® GeForce RTX™ 3090 and GeForce RTX 3080 graphics processing units (GPUs), which are tailored to support the fast speeds that immersive, high-performance gaming applications demand.

As PC gaming evolves in sophistication, gamers today demand the highest performance for their advanced graphics cards — a requisite for smooth animation, sharp visuals, 8K resolution and real-time ray tracing, a rendering technique that results in realistic light reflections and cinematic effects.”

     Without getting too technical, until recently, graphics memory was capped at 64 gigabytes per second (GB/s), transmitting one bit per cycle in data encoded as 1’s and 0’s.  Micron has created a new technique, called PAM4 which employs four distinct levels to transmit two bits of data to and from memory at a time.  Therefore, Micron’s GDDR6X increases memory bandwidth to 84 GB/s, greatly enhancing the performance of these graphics processors that NVIDIA manufactures.

     This is important because what it means is that NVIDIA is specifically tailoring one of their chips to a Micron product offering.  This is an example of a type of de-commoditization of a memory product.  If Micron can continue this and create proprietary types of memory that are tailor-made to certain applications, then their products will be less commodity-like, meaning that Micron can price these products at a premium and hold valuable patents on the technology.  

     Micron plans to offer GDDR6X to other companies too.  Ralf Ebert, A spokesman for Micron said:   “We can now start offering and opening this up to the industry, GDDR6X is not customer-specific.  We expect other customers to have interest moving forward, and then we will also engage with them.”  He goes on to say:  “PAM4 was a challenge, and we believe that with this breakthrough, this can be done moving forward.  This will, we believe, change the DRAM industry. We were the first ones to have done this, and we have been working on this for quite a while.” 

     This proprietary type of memory from Micron shows they’re the most innovative memory company, and can be an argument for why Micron isn’t a commodity company, but one that can sell unique products.

     As gaming becomes more graphics-and-processor-intensive over the years, Micron will be able to benefit by providing memory solutions for this industry.  In general, the gaming industry is growing fast and that should be a positive for Micron as the need to store exponentially more data arises.  The gaming industry is set for an upgrade in graphics needs so more users will need to get better, faster chips if they want to play the newest games.

Source:  www.newzoo.com/globalgamesreport  

     Another thing to note is that the COVID-19 pandemic has accelerated the pace of digital transformation in the economy.  Trends that would have taken 5 years to develop have been accelerated into months.  This works to Micron’s advantage.  More people are working from home, more people are gaming.  This has resulted in a boom for notebooks, laptops, and new-gaming consoles. 

     Online activity such as e-commerce, gaming, and video streaming has all increased which drives additional data center capacity requirements.  Online learning is also expected to play a bigger role in the future, driving more storage demand.  While consumer-end markets such as auto and smartphones have taken a hit, Micron expects these markets to eventually recover as the pandemic subsides, restrictions are eased, and people start spending again.  Surprisingly, none of Micron’s production capacity has been affected by the pandemic.

     Another tailwind that should benefit Micron well into the future is the growth of artificial intelligence (AI) products in the economy.  AI applications will require gargantuan increases in the capability of processing power and memory needs.  Self-driving cars, cybersecurity, healthcare, marketing, finance, and other areas are all primed to be taken over by artificial intelligence. 

     Micron noted in its financials that AI servers have about six times higher DRAM content than a standard server and these servers also use a lot more NAND than a standard server.  All of these changes will drive higher consumption of memory and storage for the long-term.

     The adoption of 5G for smartphones is also expected to be a positive for Micron since 5G phones have greater storage capacity than 4G phones.  5G phones have 6GB of DRAM and 64-128GB of NAND versus 4G phones having 2-4GB of DRAM and 32-64GB of NAND.  The larger amount of sub-$250 smartphones will make 5G accessible to a broader market and will be a positive for Micron.

     In addition, as autonomous vehicles become more of a reality for many consumers, these cars will have immense memory requirements due to the software in the car needing to quickly be able to analyze its environment and make driving decisions based on a myriad of factors.

     Furthermore, the migration to cloud computing by consumers and especially large companies and organizations will continue to drive the demand for memory solutions.  The cloud eliminates the need for companies to purchase and maintain expensive computing hardware, pay for hosting, and develop software to maintain their servers. 

     As organizations collect ever-increasing amounts of data, that data will have to be stored in the cloud in huge off-site data centers owned by, say Amazon, Microsoft or Google.  These data centers will drive demand for more complex memory and storage products.  They will have to store data that will increase at an exponential rate over the next ten years.  This is another secular tailwind that will drive Micron’s revenue growth.

Source:  https://www.prnewswire.com/

     Let’s take a look at the total addressable global market size for semiconductor memory solutions and how it’s expected to grow over the next several years.

Source:  https://www.grandviewresearch.com/industry-analysis/the-global-semiconductor-memory

     This is a market that’s expected to grow at a healthy 6% per year and possibly more especially as demand for smartphones and global internet-connectivity increases in areas such as China and India.

     Another thing to note about Micron is that it’s in a very capital intensive industry, in which the barriers to entry are high.  Micron also has an immense amount of intellectual property that’s not easily replicable.  The point is that it’s not easy for any start-up to simply enter this business. 

     A new competitor would have to build the factories, buy the equipment, create their own products that don’t infringe on Micron’s patents, and hire a highly sophisticated workforce.  Not an easy task.  This is why Micron, as one of the big three memory companies, is in a strong moat position with the ability to keep competitors at bay.  That will allow it to continue generating excess returns.   

     You as an investor in Micron are also in good company with some super-investors that have recently made Micron a large portion of their portfolio.  These are Mohnish Pabrai, Prem Watsa, Guy Spier, and Li Lu.  If you can, check out some writings of these investors.  There’s much knowledge to be gained.

Financial Metrics

     Now we’ll look at some metrics for Micron stock and calculate factors such as what rates of return it earns on its capital and how cheaply or richly the stock is priced as a multiple of earnings and cash flows.

As of 9-15-20

  • Price:  $49.16
  • Shares Outstanding:  1131m
  • Market Cap:  $55,600m
  • Enterprise Value:  $53,298m
  • P/FCF:  189
  • EV/EBITDA:  6.6
  • ROE:  6%
  • ROC:  6%
  • ROC2:  6%
  • FCF/REV:  1.5%
  • P/E:  24.5
  • P/S:  2.7
  • D/E:  17%
  • D/Mkt Cap:  11%
  • Operating Margin:  12.4%
  • EBIT/TEV:  4.7%
  • GP/TTA 5-yr avg:  29%

(See “Definition of Terms” section below for an explanation of what all these metrics mean.)

     The above metrics are based on trailing 12 month data for Micron.  At a glance, they don’t look very impressive.  The ROE and ROC numbers look mediocre, the P/E doesn’t seem cheap, the operating margin isn’t that great, and the EBIT/TEV enterprise yield doesn’t make it look cheap.  However, we have to realize that over the past 12 months we’ve experienced a trough in prices for memory chips and much oversupply in the industry.  The coronavirus pandemic further eroded demand. 

     However, Micron has recently lowered their production and management has stated in conference calls that they expect demand to pick back up and memory prices to improve in the second half of 2020.  As the pandemic is put behind us, this should improve the above numbers for Micron.  

     A positive thing to note is that Micron has been aggressive in buying back its shares over the last few years.  From fiscal year 2018 to fiscal year 2019, it reduced its share count by 7%.  As an investor, for you this means that you’re able to get a larger share of the earnings pie.  

     Micron is also benefiting from the leadership of a great CEO in Sanjay Mehrota.  He was co-founder of SanDisk and when it was acquired, joined Micron in 2017.  He brings 30 years of experience in the semiconductor industry to Micron.  He used 70% of their $3.8 billion in free cash flow to repurchase shares year-to-date, resulting in about an 8% reduction in share count since last year.  The repurchases, occurring during a cyclical trough at low stock prices is a wise capital allocation strategy.  We wish more CEOs would buy back stock at cyclical lows instead of highs.

     Remember, investors and the marketplace are always looking forward toward the future.  The above numbers represent the past and while they may give us a glimpse of how profitable or cheap the company is, what we really need to do is make some logical estimate of what earnings and cash flows will look for Micron in a normalized environment.  This is what we’ll do in the next section as we construct a discounted cash flow (DCF) model in an attempt to estimate the value of Micron’s stock.

Discounted Cash Flow Valuation

     We’ll use a free cash flow model to estimate the intrinsic value of Micron’s stock.  We’ll have to make reasonable forecasts for revenue growth for the next ten years as well as how much of that revenue is translated into free cash flow available to shareholders.  We use free cash flow after buybacks since the money that Micron uses to buy back stock isn’t really available to us; it just reduces the share count.  Therefore we need to assume that Micron will spend a certain amount of free cash flow yearly to buy back stock.  In our model we assume that free cash flow after buybacks is 15% of revenue on average, similar to what it’s been in prior years.

     We then make an estimate of what multiple of revenue we’ll be able to sell the stock for in year 10.  That’s called our “terminal value.”  The P/S ratio has averaged about 2 for Micron over the past several years so we assume we can sell the stock for 2 times revenue in year 10.  

     We discount each year’s cash flow by a discount rate to get present value for today.  Finally we sum the discounted cash flows to get a value for the firm.  To get equity value we take this number and subtract debt and divide by shares outstanding to get an estimate of value per share for Micron.

     We come up with an intrinsic value of $75.99 for Micron, representing 54% upside from the current price of $49.16.  Now, of course there’s many assumptions built into this valuation.  We assumed that revenue growth would be down 10% in 2020 according to management’s guidance.  Then we assume that it bounces back and resumes the growth trend as shown above. 

     We also assume that free cash flow after buybacks averages 15% over the next 10 years, that we’re able to sell the stock in year ten for 2 times 2029’s revenue, and that the share count gets reduced an average of 2% per year. 

     Here’s a link to the Google Docs spreadsheet so you can play with the numbers and assumptions yourself to see how they affect intrinsic value.  (It’s in view-only mode so you’ll have to copy and paste into your own spreadsheet to make changes.)

https://docs.google.com/spreadsheets/d/1dedRd1TBImpAKZn730hkqLgtc1DGX99EvuJWXCbZDw8/edit?usp=sharing

Relative Valuation

     Now let’s compare and contrast some numbers to see how Micron’s stock is priced relative to its competitors.  (See “Definition of Terms” section below for an explanation of what these ratios mean.)

     It looks as though Micron is very similarly priced to the pure-play memory companies such as SK Hynix and Western Digital along with similar returns on capital, operating margins, and P/E.  Samsung is the behemoth company here and it looks like it has a better EBIT/TEV enterprise yield along with cheaper EV/EBITDA and better return on capital (ROC).  Samsung is a much more diversified conglomerate electronics manufacturer however, so maybe comparing it to pure-play memory companies isn’t appropriate.  But it’s still informative. 

     Again, these numbers are all from the last 12 months which has been a difficult time for memory and storage companies.  It may not give us a good indication of what the future will look like.  Which is why we need to make some informed forecasts as in our DCF model above.

Risks

Of course, investing isn’t without its risks and Micron has several risks we should be aware of as investors.  Some include the following:

  1. The average selling prices for memory products are volatile and they go through periods of oversupply where Micron may not be able to sell their products at profitable prices.
  2. They have large fixed costs due the capital intensive nature of their industry.  Their costs do not vary proportionally with changes in production output.  Therefore, Micron can experience losses if they aren’t able to sell enough units at a high enough margin.  
  3. The semiconductor memory and storage markets are highly competitive.  If Micron isn’t able to offer top-of-the-line innovative products, their competitors can encroach on their market share.
  4. Micron is restricted from selling a certain portion of their memory products to Huawei, which has been put on a blacklist by the US.  In 2019, Huawei represented 12% of Micron’s revenue.  This could be a negative for Micron’s stock if they aren’t able to continue selling to Huawei while other competitors have no such restrictions.
  5. Trade tensions between the US and China could prohibit Micron from selling memory products into the Chinese market.
  6. A potential threat to the profitability of the memory market at some point in the next several years could be China, with its $20 billion Integrated Circuit Industry Investment Fund encouraging the development in China of memory chips.  They could potentially flood the market with cheaply priced memory chips and cause a collapse in profitability.  At present however, China imports mostly all of its memory chips and exports very little, and we don’t expect that to change in the near future.  Although they could enter the market, it’s most likely many years away, and the transition won’t be seamless.  China has to build the plants, hire the talent, and develop the technology that’s on par with the quality of what Samsung, SK Hynix, and Micron are putting out right now.  It won’t happen overnight, but it’s something to monitor.

Ratings

  • Value:  4/5
  • Growth potential:  4/5
  • Balance Sheet:  5/5
  • Management:  4/5
  • Moat:  4/5
  • Overall Rating:  4/5    

Disclaimer:  This article should not be considered investment advice.  Do your own research before investing and verify any claims or numbers stated herein.  

Definition of Terms

Market cap:  This is the market capitalization or the value of the equity in the company.  It’s simply price per share multiplied by shares outstanding.

Enterprise Value:  This is the total takeover value of the firm.  It’s the value of equity plus the value of debt minus cash.

P/FCF:  This ratio is the price per share divided by free cash flow per share for the trailing twelve months.  The lower this ratio, the “cheaper” the stock.

EV/EBITDA:  This ratio is enterprise value divided by earnings before interest, taxes, depreciation and amortization for the trailing twelve months.  The lower this ratio, the “cheaper” the stock.

ROE:  Return on equity.  This is calculated as net income for the trailing twelve months divided by beginning shareholder’s equity.  The higher this percentage, the better.

ROC:  Return on capital.  This is calculated as net income for the trailing twelve months divided by beginning capital employed.  Capital is calculated as shareholder’s equity plus long-term debt minus goodwill and intangibles.  The higher this percentage, the better.

ROC2:  Return on capital 2.  This is another way to calculate return on capital, mostly applicable to industrial companies.  It’s the same as ROC above however “capital” is calculated as current assets minus current liabilities plus net property, plant, and equipment.  The higher this percentage, the better.

FCF/REV:  This ratio is free cash flow for the trailing twelve months divided by revenue for the trailing twelve months.  This represents how much of revenue is being translated into free cash flow that can be used for dividends or buybacks for shareholders.  The higher this ratio, the better.

P/E:  This ratio is price per share divided by earnings per share for the previous twelve months.  The lower this ratio, the “cheaper” the stock and vice versa.

P/S:  This ratio is price per share divided by sales per share for the previous twelve months.  The lower this ratio, the “cheaper” the stock and vice versa.  It’s usually used when companies have negative earnings per share, which makes the above P/E ratio meaningless.

D/E:  This ratio is total long-term debt divided by shareholder’s equity.  It represents how much debt a firm is using relative to its equity.  The lower this ratio, the “safer” a firm’s balance sheet is considered.

D/Market Cap:  This ratio is total long-term debt divided by market capitalization.  It represents how large a firm’s debt size is relative to its market cap.  The lower this ratio, the “safer” the firm’s balance sheet is considered.  This ratio is used when a firm’s equity is negative on its balance sheet.

Operating Margin (EBIT/REV):  This ratio is operating income divided by revenue for the past twelve months.  Operating income is also referred to as earnings before interest and taxes (EBIT).  The higher this ratio, the more profitable a firm is.

EBIT/TEV:  This is known as the enterprise yield.  It’s calculated as earnings before interest and taxes divided by total enterprise value.  The higher this percentage, the better.  If you flip this ratio around and take the inverse, it’s known as the enterprise multiple, and the lower that ratio the better.  They both represent the same thing however in that it tells you the “cheapness” of a stock.

GP/TTA 5-yr. Avg:  This ratio is gross profit for the previous twelve months divided by beginning total tangible assets.  Tangible assets are simply total assets minus goodwill minus intangibles.  The higher this ratio as a percentage the better.


Robert Nowak is the founder of RTN Investments, LLC.  RTN is a registered investment advisory managing separate accounts for clients and is modeled after Warren Buffett’s original partnerships.  RTN’s goals are the preservation of client’s capital and to outperform the S&P 500 on a rolling 5 year basis by investing in undervalued stocks of high quality companies.