Micron Technology's (NASDAQ: MU) stock price has experienced some volatility in the past 3 months with it down as much as 20% from its 6 month highs. Downward pressure on the stock's performance has come from a number of directions including: weakness in the PC end market, overall weakness in DRAM pricing and rumors that Samsung will increase capacity in memory markets disrupting the current supply and demand balance. Despite some of these negative influences, we think there is still considerable upside with a valuation that could even approach $50.
Addressing The Concerns
Last year, Microsoft discontinued support of its Windows XP platform pushing forward an upgrade cycle that was responsible for a particularly strong year in PC shipments. Unfortunately while this was good for Micron in 2014, DRAM sales won't be benefiting from such a push this year. The PC end market has historically represented about 30% of the DRAM end market but the segment continues to experience continued weakness. Fortunately this weakness has long been anticipated and should be priced in already. In the long run the growth drivers for the DRAM market will be driven by the mobile market, which we'll touch on later. DRAM pricing also tends to be seasonally weak during the first quarter and should recover into the rest of the year.
Spot Price for 3 Gigabit DRAM Module (InSpectrum Technology)
As for the concerns about rumors that Samsung may oversupply the market with excess capacity, these fears are overblown. As the world's largest DRAM and NAND supplier, the memory segments account for a large proportion of Samsung's profitability. The company has little incentive to bomb the market and shift the supply and demand balance. DRAM supply is expected to remain tight going into the rest of the year which is good news for the market.
The Good News Ahead
On the DRAM side, the growth vectors for the company come along two fronts. The first as we mentioned earlier is in the mobile market, which will continue to increase in both units shipped as well as GBs per unit. Currently the average mobile device contains around 700MB of DRAM. The industry is on a trajectory to average 2GBs per smartphone in the next two years. The next iPhone is currently rumored to have its memory capacity increased from 1GB to 2GB of DRAM, while the Samsung S6 is expected to ship with 3GB of memory. The second area for growth in the DRAM segment comes from Smart TVs, a segment we don't often associate with memory products. 4k/Ultra High Def TVs currently make up around 10% of the total LCD TV market of which 220M units are sold annually with some UHD TV shipping 4 GBs of memory. Over time the total bit demand from TVs alone could be as much 2/3 the size of the PC market by itself.
Another positive area for the DRAM business is the new agreement with Inotera. The new margin sharing agreement announced during the winter analyst day, will begin in CY 2016. Through margin sharing Micron will also share in any of the downsides in the memory market but given the strength of the market this could offer Micron $0.30 - $0.60 of EPS upside in that year.
In NAND, we expect a recovery in the 2nd half of this year. Micron has been under-earning its competitors Sandisk and Samsung in the NAND market. The big news is the new relationship with Seagate (NASDAQ: STX) and the upcoming technology upgrades. The company expects that this should lift margins on the NAND segment by 10%, which should equate to around 30 cents of EPS.
Micron is expected to do $0.75 of EPS in their fiscal year 2nd quarter which annualizes to $3.00. Costs per bit in both DRAM + NAND have fallen historically around 5% quarter over quarter. In a flat to strengthening pricing environment the margin expansions should account for an additional annual EPS accretion of $0.40-$0.50. Lastly the company also announced $1 billion in stock buybacks last year and has been active in the market. This should equate to around a 5% reduction in fully diluted shares, adding as much as $0.15 of EPS in 2016.
EPS Contribution Buildup into CY 2016
With the stock trading at a P/E of 10-12x and the potential for $4.00+ of EPS, we think that Micron could see levels closer to the higher range of $40-48.
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