The memory chip industry has been booming for the past few years, and Micron (MU -0.18%) has taken advantage. The company has built up a large pile of cash on its balance sheet, partly the result of record profits and cash flow. That will come in handy now that demand and prices for memory chips are falling off a cliff.
Micron had about $12 billion of cash and investments on its balance sheet on Dec. 1, along with roughly $10.3 billion of debt. The company added $3.4 billion of that debt during the fiscal first quarter, a move meant to strengthen its cash position amid deteriorating industry conditions. Micron would have even more cash if it hadn't been buying back its own stock over the past couple of years. From fiscal 2020 through the first quarter of fiscal 2023, Micron dumped $4.2 billion into share buybacks.
When you operate in a commodity industry that's going through the worst downturn in over a decade, no amount of cash is too much. Micron's free cash flow was a loss of $1.5 billion in the fiscal first quarter alone. The company is slashing capital spending and costs, but further free cash flow losses are likely as the situation deteriorates. Micron's balance sheet is strong, but it's going to weaken considerably as this cycle plays out.
An inventory problem
One thing that will make this downturn so much worse than recent downturns is the amount of excess inventory floating around. Three things have to happen before memory chip prices stabilize:
- Bloated inventory levels at customers like PC OEMs and cloud computing providers need to be worked down. During this process, Micron and fellow memory chip manufacturers will see demand far below end-market demand.
- Once customer inventory levels are back to healthy levels, inventory levels at the manufacturers themselves must be brought down to healthy levels.
- Once excess inventories across the industry are removed, either end-market demand must catch up with production levels, or production levels must decline to meet demand.
All of this is going to take a while to play out. Micron expects industry profitability to be "challenged" through calendar 2023, although it does see things starting to improve in the second half. Demand for PCs has plunged unexpectedly this year, with unit shipments dropping nearly 20% in the third quarter. Micron also expects sluggish demand for smartphones and weakening demand from cloud computing customers as those customers work through existing stocks of memory chips.
While it's hard to know exactly how much inventory is bogging down Micron's customers, the company's own inventory situation is quite severe. Micron had $8.36 billion worth of inventory on Dec. 1, up from $6.66 billion three months prior and $4.83 billion one year ago. And since per-bit prices are dropping so quickly, the number of bits of inventory is likely rising much faster than the value of that inventory.
We can look at days inventory outstanding (DIO) to better understand the hole Micron is working its way out of. This metric measures the average number of days that a company holds inventory before that inventory is sold and converted into revenue. Micron's DIO is currently 214, far above historical levels. It might be the worst ever.
MU Days Inventory Outstanding (Quarterly) data by YCharts
Micron's inventory situation suggests that this downturn is going to be extremely severe, and that it's going to last longer than any downturn in recent memory.
Weathering the storm
Thankfully, Micron's balance sheet has enough cash to weather just about any storm. The company could burn cash for the next year, which it may very well do, and still have plenty of liquidity remaining. Micron will make it through this cycle, although the balance sheet will certainly be weakened in the process.
Whether Micron is a good investment right now is hard to say. The company trades at a price-to-book value of about 1.1, close to where that metric bottomed out in recent cycles, but this cycle is likely to be so much worse than those. As the company burns through cash and potentially writes down inventory, its book value will deflate.
It may be best to wait to buy Micron stock until any remaining optimism has been snuffed out. It's going to get worse for the company before it gets better, and I suspect the stock could hit much lower levels in the coming months.
