Micron – Approaching The Buy Zone (NASDAQ:MU)
Micron Technology (NASDAQ:MU) stock has given investors a wild ride this year. The stock is down 45% year-to-date, but it went on a rally between late September and mid November despite an underwhelming earnings release. In the third quarter (fiscal fourth quarter), Micron guided for near $0 in EPS in the next period. The earnings release for that “next period” will be out tomorrow, so we won’t need to wait that long to see how it all went down.
Personally, I was not impressed with Micron’s last release. I knew that earnings would go down but I was not expecting the company to guide for $-0.10 to $0.10 in EPS. For context, it had been earning as much as $2.59 per share in prior quarters. The actual results seemed like a huge step backward. After some thought, I sold 75% of my shares, keeping 25%.
Right now, I’m content with the Micron exposure I have in my portfolio. It’s a sizable but not overweight position that should do well after the current macro headwinds abate. For the upcoming quarter, I want to see one thing, and one thing only:
A large miss.
I’m hoping that the quarter’s earnings and guidance are terrible, and that the stock sells off after they come out.
You might find it funny to hear me say that I want earnings to miss, given that I’m a Micron shareholder. The reason has to do with my current position size, and Micron’s asset-based valuation. First, my MU position size is fairly small, about 2% of my total portfolio. My ability to pay the bills would not be seriously impeded by a further drawdown. Second, Micron’s book value per share is $44.11. If the stock falls below that level then investors get a significant margin of safety: the shares will be objectively worth more than their price. We’re not there yet, but I’ll be buying back all of my original Micron position if it happens.
Theoretically, enough poor earnings releases could eat into a company’s book value, by (e.g.) requiring more debt to keep things running. However, the semiconductor industry is cyclical: weakness in semis is expected from time to time. For cyclical industries, bad quarters don’t predict future bad quarters: they merely show that we’re approaching a low ebb in the business cycle. If the semi industry keeps behaving as it always has, then it should recover at some point in the future, and Micron’s selling prices and shipments will pick up.
Most economists predict that the highly anticipated 2023 recession will be “mild” at worst. If their predictions come true, then this entire cycle should conclude with minimal encroachments on Micron’s book value. So, I’m looking forward to an opportunity to buy it at a price/book ratio of 1.
Micron’s Business – a Basic Overview
Before getting into why I think Micron is a buy at a price/book of 1, I need to explain its business. An obvious counterpoint to an asset-based investment thesis is that enough poor earnings releases could eat into book value. For example, by forcing the company to take on debt in order to stay afloat. So, I’ll have to explore Micron’s business in detail to show why that’s not likely to happen.
Micron Technology is a tech company in the memory sub-sector of the semiconductor industry. It sells DRAM (random access memory) and NAND flash (SSDs and micro SD cards). DRAM made up 72% of revenue in the most recent quarter, which is a good thing because DRAM is the most profitable part of Micron’s business. DRAM is an oligopoly between three main players: Micron, Samsung (OTCPK:SSNLF) and SK Hynix. Technically there are other players in the space but they have less than 2% market share combined. High levels of concentration tend to lead to high margins, so Micron’s 28% net margin in the trailing 12 months (“TTM”) period shouldn’t be too surprising. The company has a solid competitive position in DRAM. The NAND flash space is more competitive, with about a dozen sizable players, and naturally the margins there are slimmer.
The big thing you need to know about the RAM market is that it’s cyclical. When times are good, tech companies make a lot of sales, they buy RAM to go in their devices, and RAM prices rise. It’s the opposite during contractions: volumes and prices go down. Right now, we are in the midst of a slowdown in the tech sector. The overall economy grew 2.9% last quarter, but that was largely due to non-tech sectors. Big tech companies saw slow revenue growth in Q3; some laid thousands of people off, most are at minimum freezing hiring. There’s still a lot of demand for smartphones, laptops and online advertising, but the tech companies had such a good year in 2021 that base effects are starting to come knocking at their door. They’re now sitting on a glut of RAM that will have to be sold before prices begin rising again.
Why I’m Hoping for Weak Earnings
The reason I’m hoping for a weak release from Micron tomorrow is because it could take the stock down to book value. Yes, poor operating results are bad, but remember the point about cyclicality. For a cyclical company, a bad quarter does not predict future bad quarters, if it occurs because of a low ebb in the business cycle. Cyclical companies generally have bad earnings during poor economic conditions, it’s in their nature. Even if the earnings are worse than expected, it doesn’t tell you how the company will do in the next economic expansion.
In Micron’s case, we do know that if it falls to $44.11, it’s trading at book value. At that level, a dollar worth of MU stock has a claim to dollar worth of assets, net of debt. At levels lower than that, you’re paying for less than what you get. In the meantime, any weakness in the upcoming earnings would be assumed to correct in the next phase of the business cycle.
Micron Technology: Asset Based Valuation
In most articles, I value stocks based on earnings/cash flow multiples and discounted cash flow models. For companies that are thriving, these kinds of approaches are appropriate, because their shares rarely make sense from a “deep value” asset-based perspective. In Micron’s case, though, we’ve got a strong case to be made that the company could be a buy based on just assets pretty soon.
Here’s what we know about Micron’s assets:
The company has $44.11 in book value per share.
It has $21.7 in current assets and $7.5 in current liabilities, for $14.2 billion in net working capital.
With 1.094 billion shares outstanding, that’s $12.97 in working capital per share.
Cash per share is $7.55.
At today’s stock price (about $52), Micron is already cheap compared to these metrics. However, its ratios of stock price to all of the above numbers are currently above one. There is no true Ben Graham style “deep value” here.
What’s interesting is a potential scenario where MU stock falls to $44. At that level, the price/book ratio is 0.997, the price/working capital ratio is 3.4, and price/cash is 5.82. These are truly rock bottom multiples. You’d expect a tiny amount of upside here just by price rising back to book value (about 0.25%). If Micron fell to $12.90, it would be a net-net, indicating deep value and truly extreme undervaluation. I’m not expecting Micron to go to $12.90, but if it did, it would be one of the best value opportunities in the tech sector.
Now, there is the possibility that poor earnings will eat into Micron’s book value. The high end of last quarter’s guidance was $0.10. Micron’s dividend annualizes to $0.43. If Micron continues paying the dividend while earning $0.10 per quarter, then it will have to dip into its cash pile to make the payments. However, with cash per share sitting at $7.55, the effect would be pretty minimal. If the tech industry gets moving again by the end of 2023, only a few cents worth of dividends per share will have been paid out in excess of earnings.
Risks and Challenges
As we’ve seen, Micron is a truly cheap stock, trading only a little above book value. It could be a good play if it hits $44, and it’s a decent bet at today’s price. However, there are some risks you’ll want to be aware of:
Dividends eating away at book value. As mentioned previously, Micron has guided for $0.10 (or less) in Q4 earnings, and it’s paying $0.43 in annual dividends. If Micron were to earn $0.40 per share per year, then it would have to spend its cash (or borrow money) at a rate of $0.03 per share per year to make its dividend payments. That would eat away at book value, albeit very slowly.
New competitors. Micron’s earnings should rise again in the next phase of the business cycle, but exactly how much is up for debate. Currently, Micron’s margins are protected by industry consolidation: it has only two large competitors. Should new ones emerge, profitability will likely suffer.
Going all-in ahead of earnings. Much of my thesis in this article revolves around a specific scenario where Micron falls to $44 after earnings, and rises from there. If you go all in on Micron right now, you might get burned. I think that Micron is a decent long term bet at today’s prices, but the really attractive entry points are below $44.11. That’s where “deep value” becomes a real part of the conversation.
These risks are very real. In fact, they are real enough that I reduced my exposure to Micron after thinking about them. Nevertheless, I think a little exposure to Micron is worth having. If the stock hits $44, it’s time to double down.