A US Large Cap Special - Micron Technology

21st Aug '18 by Keelan Cooper

18 comments 4841 reads

With over 10,000 stocks to pick from, the US stock market offers investors unrivalled opportunities - ranging from iconic names to exciting start-ups. However, for many investors, investing abroad in markets like the US can still be quite daunting and not without risk.

As a UK based investor, exchange rates and trading costs are a factor worth bearing in mind when venturing across the Atlantic. The exchange rate environment is not very favourable at the moment and the pound is currently at near one-year lows against the dollar, with £1 currently buying you just over $1.28. However, as “no-deal” Brexit fears persist, and it becomes an increasingly plausible scenario as the 29th March 2019 deadline approaches, the downward pressure on the pound will likely intensify. In that case, holding US shares may be a good way to benefit from the weakening pound.

Trump’s trade policies are a regular feature in the news, and investors looking at US companies are right to question what they might mean for them going forward. If Trump is successful in bringing China to the negotiating table then it could lead to more favourable terms for US based companies trading abroad. But if China continues its current stance, and the US proceeds with 25% tariffs on $200 billion worth of Chinese goods, then in a worse-case scenario, US companies could miss out on a potential 1.4 billion consumer market.

Whatever one may think of Trump’s global policies, there is no doubt that the US economy remains strong, resilient and bullish. In the second quarter of 2018, it was growing at an annual rate of 4.1%, its fastest rate in 4 years and well ahead of most major developed economies. The current volatile environment has also carved out new opportunities in the market.

One interesting prospect is Micron Technology, a Nasdaq listed company, which is a market leader in the field of semiconductor systems. The company offers a range of products to drive optimal memory and storage solutions in applications such as mobile devices, PCs, data centers, Artificial Intelligence (AI) and autonomous vehicles. It is the only company in the world to provide DRAM, NAND and 3D Xpoint technologies.

DRAM, which stand for Dynamic Random Accessory Memory, is what determines the performance of your technological device. In computers, for example, whether you are surfing the web, loading applications or keeping…

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Brilliant Leader

21st Aug '18

Hi Keelan

Thanks for taking the time to write this up, it is one of the best company write-ups i’ve seen in a long while. Micron is duly added to my watchlist.

JatinBPatel

Dear Keelan,

Thank you for a very good write-up!

Jatin

Frank Ballard

Thanks for giving us a broader background, plus a deeper look into this opportunity. Micron has been on my watch list, and this gives me a much greater understanding of what's ahead.
Frank

JohnEustace

I have held Micron for 18 months and so have had a decent return, but the market does seem determined to keep it cheap. The thing "everyone knows" is that it's a cyclical business and so that is being priced in.

The counter argument is that the past was a function of the Windows/Intel PC upgrade cycle and that these days the drivers are smartphones and cloud computing, IoT, and AI as you say in your write-up. And management are confident enough of that to launch that massive buy-back programme.

The demand for memory is essentially infinite. We would all like ten times the storage in our phones and computers if it was cheap enough, and we are all storing more of our photos and videos in the cloud.

There is an argument that the computing paradigm is shifting to be memory-centric rather than processor-centric. The ability to rapidly access the memory is the critical factor rather than the ability to process instructions. But the new standards are not set - or rather Intel has their standard and the rest of the industry has a different one. Intel and Micron are going their own ways on XPoint, bringing their joint development programme to an end.
In my view Intel should buy Micron in order to stay relevant. Maybe when Intel get a new permanent CEO the rumours will start up.

Andrew L

Thanks for this write-up. If you know the main reasons why the shares are at such as low P/E ratio that would be interesting to hear your thoughts. I.e. investors or the markets main worries and why you think they are wrong. Some initial thoughts below:

Looking at the group and 51% of revenue is to China and 12.5% to Taiwan. So I guess this is what the market may be focusing on? Most of the assets are in Taiwan and Singapore combined. Capex has been higher than depreciation from fiscal 2014 to 2017 so when the investment cycle ends they may have a lot more free cashflow. However, capex is also expected to be higher than cashflow in 2018, 2019 and 2020.

On the quality front the long-term ROCE performance isn't great. The business appears to be very capital intensive with each US$1 of investment generating about US$1 in a good year. The EBIT margin is good but this is offset by the capital intensity of the sector I guess.

So I guess the thesis is that this will be a much higher quality business going forward for the reasons you outline. I guess one reason for the low rating might be that while earnings are expected to increase significantly in fiscal 2018 they are then expected to decline in the following two years.

Free cashflow conversion has historically not being great. Capital employed has also increased from US$18bn at the end of fiscal 2014 to US$30bn at end of fiscal 2017. I do like the fact that the net cash position is expected to increase in the coming years. The share buy-back also looks positive. This is typically the approach taken for cyclical businesses i.e. Ryanair.

Summary: This is a fairly capital intensive business and has been cyclical in nature historically. Probably people are focused on the risk that this company will be shut out of its largest market: China. For me the underlying business quality is ok but not great. Free cash flow conversion has been weak, capex exceeds depreciation, capital employed has increased significantly and this is a capital intensive sector. The underlying result is that ROCE is unlikely to hit very high levels. This is an initial view and could be wrong. If your argument that demand is more secular in nature this will keep ROCE from falling back significantly. But can this really be a quality business with ROCE consistently above 15%? We shall see I guess.

The trouble with capital intensive businesses for me is that they tend to always be cyclical. The heavy capital investment cap lead to industry over investment and declining prices. It also puts a heavy drain on cashflow. There is always the risk that capital investment will be spent on areas that don't bear fruit. So this probably wouldn't be the kind of stock I would look at. But I will take a closer look at your thesis to see if I am wrong.

The trouble with the P/E metric in my view is that can appear cheap for stocks with lots of debt or where earnings don't reflect the ability to produce cash. The debt isn't an issue at Micron but the latter may be an issue. Depreciation is based on the historic cost of assets and may understate the actual cost of buying or creating them today. The P/E also always looks low for cyclical businesses at the top of the cycle. That said Micron's P/E still looks low even factoring in these issues.

Thanks again for the writeup.

aflash

22nd Aug '18

Can someone tell me what the connection is with Micron Solutions ASQ:MICR?

Reading that they contract manufacture Healthcare equipment suggests to me that the company is a subsidiary/satellite company using some Micron Technology NSQ:MU know-how.

May be in the High Quality Article somewhere but could not see it.

I can't see that there is any connection between those two companies beyond both having Micron in their name. I certainly don't see any synergy or common know-how, they are in quite different businesses.

davidbowler

Excellent article, keelancooper..

goronwy

23rd Aug '18

I agree, excellent. I bought these shares in Nov. 2017 and they dropped but have returned to the price I paid. They have low PE , high return on capital , not highly geared. Certainly looks a great share to me.
Goronwy

maffs0

Thanks for an outstanding article. This is not a share that would come onto my radar, but the quality figures in particular are fantastic.

I won't be investing though because the PE is so low that the market is telling us to beware. Now the market might be wrong and this share price might multi-bag from here but its not my kind of share. As a growth investor, stocks like this scare me. And while this year's EPS is due to see massive growth, next year's is due to fall slightly. Again, a red flag for me. The 50 day moving average is in a clear downtrend. Another red flag.

The green all over the Stock Report, the 99 Stock Rank means that this has a real chance to be a winner. Best of luck to all who give it a go.

M.

Keelan Cooper

27th Aug '18

Hi JohnEustace,

As you have said, Micron does operate in a very cyclical industry, and a lot of the risks associated with China seem to have been factored in. Despite this, the company does still seem grossly undervalued when compared to its industry peers. Micron's P/E of less than 5 is significantly below the semiconductor industry median of 15.9. The demand drivers discussed should change the cyclical nature of the industry going forward.

The point you make about Intel is very interesting. It would make a lot of sense for the company to acquire Micron. It would add DRAM to the company's memory & storage product offering, which is currently more profitable than NAND, and given Micron's current valuation it would make sense to do so sooner rather than later. Intel is also having struggles of its own right now with its CPU division losing out to Advanced Micro Devices. As it might take some time for the company to recover on this front, an immediately accretive acquisition, along with the news of a new CEO would help soothe investors worries, so it is definitely a scenario worth considering.

Hi Keelan,
I guess the other problem for any consolidation in semiconductors at the moment is the trade war. If the US competition authorities let this one go on the basis they are both US corporations, the Chinese would likely want to intervene.

mmarkkj777

Hi Keelan,
A really great report, very professional; well done. I notice they have in fact grown significantly in price (approx. five-fold over the last 2 years or so). I am not thinking of buying currently for the simple reason that I already own Nvidia and Apple (plus Amazon, which is not really a tech stock, but they are into cloud solutions), so I feel I am already as exposed to American tech. stocks as I can risk at the moment (circa. 15% of my shares portfolio). However, your report has given me enough food for thought to add Micron to my American stocks watch list. If I get disgruntled with any of the others, I will look to switch and Micron will now be on the short list.
Thanks for this great piece and good luck with your degree and future studies. For what its worth I also think, loosing 80% of your investment capital as a young teenager is also a great education and using the other 20% to gain it back is like a post-graduate phase :-)

Good luck for the future.

Bonitabeach

28th Aug '18

Hi Keelan,

The company does still seem grossly undervalued when compared to its industry peers. Micron's P/E of less than 5 is significantly below the semiconductor industry median of 15.9.

SK Hynix Inc is directly comparable to Micron Technology Inc and is currently available to purchase at a P/E below 4, it also pays a dividend. Micron is considered as a company that historically has been poorly managed; the new management is better regarded but too new to change that view completely.

Between 2012 and 2017 Micron generated $26bn in operating cash flow - $24bn of that went on "investing activities" - in semiconductors you have to run very hard to stand still.

Anybody expecting a re-rating from low P/E ratios wiil have to wait for the next profit collapse in the industry, then the P/E explodes!

Despite the above Micron was my best performer in 2017.

Disclosure: Long: Micron Technology Inc

schober

1st Sep '18

Hmmm ....... I recently came across this graph of 20y ebitda margins - which begs a qu .
http://tinyurl.com/ydchkxb2
Could MU fall back to $36?
http://tinyurl.com/yae9kh5x

Any comments?

5th Sep '18

Thanks schober that first link is interesting on ebitda margins. I think Keelan's thesis is that things will be less cyclical going forward. On a broader note I think that cyclical companies will often look very cheap in screen platforms so you have to be very wary.

Cisk

Keelan, excellent article!

Anyone tempted to invest in Micron should also take a look at the numerous articles on seeking alpha - there are a large number of recent posts, many of which suggest the company is undervalued.

Consensus seems to be that the Trump(‘ed up?) tariffs have been the main reason for recent underperformance.

These may be a short term headwind, but should be a tailwind once the tariff situation is resolved (and these things have a habit of being resolved, it’s just a question of when).

I agree that long term share price performance of Micron is heavily dependent on AI and the increased memory and processing power it requires. Of course, this being tech, maybe AI programs will become more efficient as they become more powerful.

7th Sep '18

Just to reiterate that I am no expert on Micron but my general view is that this is probably a capital intensive and cyclical industry. Even with fewer players and demand that is more stable you will still have periods of oversupply and lower prices. I also think you have to be very wary of looking just at the recent ROCE. This can be increased by previous capital losses and one off profits. My view on Micron is that it isn't a high quality company. It looks average or below average. But in any event it is great to get an investment thesis out there to be debated. So thanks again for the article.

Some recent warnings on memory prices and demand:

https://www.cnbc.com/2018/09/06/micron-chip-stocks-plunge-after-morgan-stanley-warns-about-weakening-semiconductor-demand.html

A US Large Cap Special - Micron Technology

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Keelan Cooper

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