One of the more hotly debated stocks in the market is Micron Technology (MU 4.81%), a leading producer of DRAM and NAND flash memory chips. Memory chips are subject to dramatic price swings, and after DRAM prices spiked in 2017 and 2018, DRAM prices are cratering in 2019.
In fact, DRAM prices -- where Micron earns a vast majority of its profits -- fell over 20% just in the first recent quarter, after falling in the high single digits during the prior quarter. Not only that, but research site DRAMeXchange projects DRAM price declines will continue, with a further 15%-20% drop in the current quarter and another 10% in the third quarter. If those projections are correct, DRAM prices will have fallen about 60% in just one year. DRAM declines are decimating Micron's profits, which fell 46.4% in its most recent quarter.
Yet for all the gloom and doom, Micron's stock has risen 36.5% this year, though it's still 33% below the all-time highs reached last June.
The partial recovery is likely due to investor perception that the memory cycle is bottoming. However, there's considerable debate on this issue: Analyst EPS estimates for Micron's fiscal 2020 year range from $1.93 to $8.02 -- just about the widest gap one will see for a large-cap stock.
So, will Micron's earnings remain in the doldrums, or will the company see a big recovery next year?
Image source: Getty Images.
What bears see
Micron's current troubles shouldn't be brushed off. During the rise in memory prices in 2017-2018, large customers became worried about further price spikes, and purchased more inventory than needed. Over that period, the three major DRAM players -- Micron, SK Hynix (NASDAQOTH: HXSCL), and Samsung (NASDAQOTH: SSNLF) -- increased capital expenditures to crank out more output to meet demand.
However, once DRAM prices began falling, the opposite occurred. Customer buying plummeted, and the overhang of the lingering trade war made memory customers even more cautious about buying more chips than absolutely necessary. Stocked with extra inventory, demand has been even lower than already-low expectations.
Worse yet, memory producers can't just switch off production without underutilizing their factories. That's caused Micron's days of inventory to surge to its highest level in 10 years:
MU days inventory outstanding (quarterly) data by YCharts.
Since memory prices are falling, older inventory will likely get sold at a much lower price, which could hurt earnings in the quarters ahead, even if Micron sells more units.
The bullish case
Things definitely look challenging for Micron right now. However, as we've seen over the past year, things can change dramatically over a 12-month period. Here are a few reasons Micron's results could surge within a year:
1. A trade deal: Though the trade war between the U.S. and China began in early 2018, the first big tariffs on electronic equipment weren't implemented until September. As negotiations between the U.S. and China have dragged on into the spring, the cautious stance has continued, denting memory demand.
However, if a trade deal is reached, companies may finally feel encouraged buy more aggressively. In fact, another tech CEO, Steve Sanghi of Microchip Technology (MCHP 0.51%), said in February that " [a] settlement of trade would be a bonanza. Our customers and distributors are so cautious, there is low visibility... nobody wants to get stuck with anything depending on what happens."
Therefore, the entire chip space -- Micron included -- could see a big demand bounce back if and when a trade deal is consummated.
2. Cutbacks in supply: Just as the memory producers all overspent during the last memory upturn, all three players are now cutting back on capital spending in 2019. In addition to lowering its spending target from $10.5 billion to $9-$9.5 billion, Micron said it also plans to shut down 5% of its wafer production starting in the current quarter.
In addition, both Samsung and SK Hynix are also set to decrease memory capital spending this year. SK Hynix even anticipates its memory equipment spending to fall around 40%.
A refresh in demand combined with a cutback in supply would be a much better setup for memory producers next year. Just as the last boom set the stage for today's bust, today's bust could lead to the next boom.
3. 3D Xpoint: In addition to a better-balanced memory market in 2020, Micron will also take control of their 3D Xpoint fab in Lehi, Utah, later this year. Jointly developed with Intel (INTC 4.88%), 3D Xpoint is a new memory technology that is nonvolatile, like NAND flash, but faster. In October, Micron exercised its option to take full control of the 3D Xpoint joint venture.
Micron has been investing heavily in this technology, but won't begin selling 3D Xpoint until late 2019, with meaningful volumes coming in 2020. Micron's margins have been under extra pressure because of this, including 160 basis points of underutilization last quarter. However, this time next year, Micron will be selling product, and should be able to get those margin points back.
Micron will be only one of two companies to have 3D Xpoint, which will have applications in high-growth sectors such as artificial intelligence and data analytics. While its contribution will not be that meaningful compared with DRAM or NAND in the near term, investor optimism around 3D Xpoint could also help boost Micron's stock in 2020.
The other side of the cycle
While the timing of the next upturn may be in question, it will eventually happen, and perhaps as soon as next year. That's why Micron's share price has surged lately, in spite of declining results. However, with the stock only regaining a portion of last year's slump, Micron still has room to move higher in the year ahead.
