Micron Technology (MU 1.44%) was walking a tightrope going into its fiscal first-quarter results in mid-December as the market was concerned about a potential weakness in memory prices. But the memory chip specialist blew past expectations handsomely, logging strong top- and bottom-line gains and issuing stronger-than-expected guidance.
This set the stage for Micron to start 2018 on a strong note, and it won't be surprising if the stock sustains its terrific run after jumping 87% in 2017. Here's why.
The memory boom will continue
Micron has a cyclical business that's highly dependent on memory chip prices, but the good news for investors is that the positive end-market dynamics are expected to continue this year. Micron management believes that the supply of dynamic random access memory (DRAM) will increase 20% in 2018, though it is highly likely that will be easily outpaced by rising demand.
DRAM is in strong demand because of its use in cloud, data center, and mobile applications. For instance, the average DRAM content in a smartphone in 2017 grew an estimated 33.4% to 3.2 gigabytes, but it won't be surprising if the average keeps rising as marquee smartphone companies are packing their devices with more memory. And data center servers are using more as they get faster.
DRAM demand outpacing supply bodes well for Micron as it gets two-thirds of its revenue by supplying DRAM chips. More importantly, the deployment of DRAM in fast-growing niches such as artificial intelligence and self-driving cars should ensure that it enjoys growth beyond 2018.
In fact, Micron has already launched high-performance memory solutions for autonomous cars that it is shipping to multiple customers. On the other hand, emerging tech trends such as machine learning and artificial intelligence require huge data computational capacities and low power consumption, which is provided by something that's known as high-bandwidth memory (HBM).
HBM costs twice as much as regular memory and its adoption is expected to grow at over 50% a year through 2022. So, Micron has a solid catalyst on its hands because it sells tools that are used to fabricate such memory chips.
Margins and earnings are set to improve
Micron's margins have received a massive boost thanks to rising memory prices. Last quarter, the company's non-GAAP gross margin jumped to 55.4% as compared to 26% in the prior-year period. Now, improved memory pricing will potentially increase Micron's margin once again this year, and the company's focus on reducing costs will prove to be another tailwind.
Micron recently recruited a new executive to head the company's newly minted global operations unit, including supply chain management and procurement. The chipmaker has tasked this unit with cost reduction responsibilities by improving manufacturing and supply chain efficiencies, and the good part is that the cost optimization initiatives are already under way.
Micron is ramping up the assembly and testing capacity of a new back-end factory in Taiwan where it plans to migrate production soon so that it can increase output and reduce manufacturing costs. Additionally, the company is looking to build a chip packaging factory in Taiwan to improve its supply chain. This is a smart move given that Micron sources 60% of its DRAM bit supply from Taiwan.
So, it is not surprising to see analysts expect Micron's bottom line to grow at a terrific pace not just in the short run, but also in the long run. According to analysts, Micron's earnings could grow at more than 27% a year over the next five years. For 2018, the earnings per share forecast stands at $9.77, up from just $4.96 a share in the preceding year.
This makes Micron Technology a terrific bet going into the new year considering its cheap valuation. Its price-to-earnings (P/E) ratio of just 6.9 is very low for a company that's expected to deliver such impressive-bottom line growth. Moreover, its P/E ratio is lower than the industry average of 7.1, and also far below Micron's own five-year average P/E ratio of 14.2. This all makes it a top stock pick in my book.