It has been difficult historically to invest in Micron Technology (MU 1.78%) thanks to the highly cyclical nature of the semiconductor sector. In good times, profitability surges to the roof, but during bad times (which happen every few years), the bottom line could plunge into the red.
But there are early signs that industry dynamics have been improving over the last few years. While the increase in memory demand -- thanks to trends like artificial intelligence (AI) adoption, 5G phones, and smart cars, to name a few -- is a significant driver, other less apparent shifts within the memory industry also contribute positively to the improving dynamics.
Here are two of these less obvious trends.
1. An increasingly rational supply addition
Memory manufacturers like Micron and Samsung compete by introducing ever more powerful memory, primarily by increasing the bits per wafer. The higher the bits per wafer -- or the higher number of transistors in an integrated circuit (IC) -- the better the performance of the memory chip. Historically, the growth in transistor numbers follows Moore's Law, which states that the density of transistors in an IC doubles almost every two years.
But as technology improves over time, the bits gained per wafer have been slowing down as it becomes more challenging to squeeze more transistors onto an IC. Physical laws become the barrier for each successive technology transition. In other words, the performance gained by adding more transistors has become lower over time, making new memory products less appealing to the older versions.
Understandably, manufacturers have less incentive to invest heavily (compared to the past) in research and development to develop next-generation products. On top of that, the capital expenditure needed to implement new-generation products becomes ever more expensive since more advanced tools and materials are needed to manufacture these complex new products.
The combination of slowing growth in transistor numbers and the growing capital requirements means manufacturers are becoming more disciplined in adding new supply, which in turn reduces price competition within the industry. While not conclusive, an anecdotal observation might illustrate the outcome of a more rational market environment: The average industry gross margin for memory and storage in the eight years from 2014 to 2021 has doubled to 40% from 20% for the eight-year cycle ended 2013.
2. A vast and expanding barrier to entry
Micron manufactures two main products: DRAM (memory) and NAND (storage). There are only three DRAM manufacturers (Samsung, SK Hynix, and Micron) and eight NAND producers (of which Micron is one) globally.
Each player (especially in the memory segment) operates at a gigantic scale. This scale is necessary to overcome the high (and ever-rising) capital requirements to design, develop, and manufacture these products. For example, Micron plans to invest $150 billion in capital expenditures and research and development in the next decade. There are just a handful of companies globally with that kind of financial might, making the barrier to entry prohibitively high for newcomers.
Besides, incumbents have significant intellectual property -- for example, Micron has 50,000 patents -- and technical know-how in manufacturing increasingly complicated memory and storage products. It would take years, if not decades, for newcomers to replicate the incumbents' technology and experience.
To put the above into perspective, Micron estimates the replacement value for its existing business is $100 billion. Assuming that a new player can afford to spend $100 billion, it will still take many years to acquire the technology and technical know-how. By then, the former would have reached new milestones.
An increasingly high barrier of entry means existing players are well positioned to benefit from demand growth amid trends like AI, 5G, and others. All they need to do is remain disciplined in adding new supply, and continue to execute to meet customers' current and future needs.
What it means for Micron
A more disciplined supply addition and an increasingly higher barrier of entry would benefit existing memory and storage companies like Micron.
While it isn't guaranteed that the above trends are permanent, there are early signs that Micron is already enjoying the fruits of such positive developments. For perspective, revenue grew by a compound annual growth rate (CAGR) of 16% and gross margin advanced by 19.7% over the last five years. The tech company also generated $21 billion in cumulative free cash flow.
If the above trends continue to take shape, Micron should see a more stable revenue trend, better margins, and ultimately sustainable and growing profits over time.