Memory-chip maker Micron Technology (NASDAQ:MU) has been crushing the market in recent years, gaining 55% in 2016 and 88% last year. But 2018 is not treating us Micron investors quite that kindly, settling for a 7.5% return so far while the S&P 500 market index gained 1%.
Are the wheels falling off of Micron's wagon? Have the good times simply stopped rolling? Let's have a closer look.
Cyclical markets run in cycles, right?
Look up "cyclical market" in a trendy dictionary and you might find a picture of a computer memory chip serving as the very definition of that phrase. This market has been prone to wild swings over the years, where a couple of years with stable chip prices and skyrocketing profits inevitably were followed by a brutal price war, several bankruptcies in the industry, and negative earnings for the next year or two.
Times have been unusually good in recent years, which is why Micron's shares soared in 2016 and 2017. The old mishmash of DRAM producers has been boiled down to just three serious names, and Micron is a member of that exclusive group. NAND storage chips add a couple more names to the mix, but that market is still led by Micron and its DRAM peers -- and it's still a very small club.
This tight grouping of memory suppliers is the result of the stronger survivors in earlier price wars buying out their failing brethren at bankruptcy discounts. Market leader Samsung (OTC:SSNLF) has been known to flood the market with an oversupply of memory chips, driving prices way down and starting one of those all-out struggles for survival across the industry. This made sense for the Korean electronics giant because cheaper chips will work in the company's favor when it comes to building affordable smartphones and other memory-equipped gadgets.
Is it any different this time?
It's been two years since the last time memory prices fell at any significant rate, but we are indeed back to that downtrend again. DRAM prices slid 10% lower in October and are expected to continue dropping through the first quarter of 2019. NAND prices dropped roughly 15% lower in October. Micron's stock followed suit with a 24% price drop of its own over the last three months. Same old, same old.
Or is it?
This is not an intentional oversupply of cheap chips. Smartphone sales have been slow all year long as consumers have been more willing than usual to stick with their existing handsets in the face of modest changes to the leading flagship phones. Some are also willing to wait for phones that can handle 5G wireless connections, which none of the current models can. On top of that, the simmering trade war with China puts pressure on the manufacturing side of things.
You could call it a perfect storm of weak demand for memory chips -- and most of these issues should resolve within a few quarters. I may be a dreamer, but even the tariff struggles with Beijing can't last forever.
This is not the next huge downturn, after all
In the meantime, all of the big names in the memory sector have reduced their manufacturing volumes in order to support the plunging chip prices. At worst, things should stabilize again in the spring of 2019. At best, the artificially low supply side efforts could meet up with recovering market demand to send chip prices upward again. In that case, 2019 should become another one of those fantastic growth periods that Micron enjoyed in 2016 and 2017. That's the opposite of the price-war environment that investors seem to be expecting any moment now.
I'm not selling my Micron shares here. The stock is trading at just 3.4 times trailing earnings and 5.2 times free cash flow, making it seriously undervalued even if the bottom line doesn't explode skyward next year.