Shares of memory-maker Micron Technology (MU +5.08%) sold off after last Wednesday's earnings report, although much of the initial sell-off was regained on Friday.
Investors may have been somewhat disappointed at the pace of the memory industry recovery as projected by Micron's forward guidance for the current quarter and fiscal year. However, a closer reading of some details may have then led some to rethink the sell-off the following day, when several analysts gave more bullish takes.
Micron usually guides conservatively, and one particular comment in the earnings release suggests upside surprises in memory pricing could be in store next year.
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Key Data Points
Micron projects growing revenue but a slow profit inflection
Micron actually beat analyst estimates for revenue and losses per share last quarter. Furthermore, Micron even guided for stronger-than-expected revenue growth next quarter, fiscal Q1 2024, with a range between $4.2 billion and $4.6 billion against analyst estimates of $4.21 billion. The midpoint of that range would suggest a 10% sequential increase.
While that was all well and good, Micron did guide to another loss per share between ($1) and ($1.14), relative to analyst estimates of a ($0.96) loss.
However, there is a lot of noise in Micron's current accounting. The company is currently taking "underutilization" charges on its fab equipment it's currently not using. Those are noncash charges and are taken as a result of Micron decreasing its production, which is also happening with its other two large Korean competitors. While these noncash charges eat into the company's gross margins, they aren't as bad from a cash flow standpoint.
In addition, Micron will see a step-up in local tax expense next quarter after receiving a credit last quarter, which is also skewing the near-term bottom-line trajectory. Finally, some operating expenses will increase as temporary employee and executive pay cuts taken during the downturn reverse back to normal levels.
Impatient investors sold the stock after earnings. However, digging into the call, Micron's forward estimates actually seem conservative. Furthermore, it appears the memory industry is setting up for its next revenue and profit boom later in 2024, due to a very specific reason.
Memory supply increases are getting harder. Image source: Getty Images.
Memory-makers are all cutting supply in concert
As Micron's last two quarterly increases in revenue show, the memory market has bottomed and is turning up. This is due to both to improving demand in some sectors like artificial intelligence memory, as well as industrywide supply cuts.
Not unlike oil, memory prices fluctuate with supply and demand. Amid the worst downturn since the Great Financial Crisis of 2008, all of the major DRAM and NAND manufacturers have cut back significantly on supply output. As of last quarter, Micron noted its supply cuts had reached nearly 30% below peak 2022 levels.
Just as when OPEC+ announces supply cuts and the price of oil goes up, memory prices, which cratered last year, have turned up. Tech publication Digitimes noted NAND prices actually started increasing at the beginning of the third quarter of 2023, with DRAM prices projected to be up in the fourth quarter.
Memory-makers won't be able to "turn on" capacity as demand returns
Of course, once demand comes back in the picture, there is a case that the memory-makers would just be able to "turn on" supply, which could temper any price increases, even as demand recovers.
But that actually doesn't seem to be the case. On the conference call with analysts, Micron's CEO Sanjay Mehrotra noted:
... we have redeployed a portion of the underutilized equipment to support production ramp of leading-edge nodes in both DRAM and NAND. Given the higher process step count of these leading-edge nodes, transitioning this equipment results in a significant and structural reduction to our overall wafer capacity in both DRAM and NAND. Due to this structural reduction in capacity, our DRAM and NAND wafer starts will remain significantly below 2022 levels for the foreseeable future. Our industry supply projections assume a similar structural reduction in wafer capacity industrywide. Lead times to increase this wafer capacity will be long and will depend on improving demand, pricing and financial performance. We expect underutilization to continue in our legacy nodes well into calendar 2024. We see our demand at leading-edge nodes exceeding our supply in fiscal and calendar 2024, particularly in the second half of the year.
Investors may want to think through these consequences. All major memory companies are currently losing money but are seeing stronger demand for newer memory nodes such as D5 and HBM for artificial intelligence applications. So, what everyone is doing is taking idled equipment from legacy nodes and plugging them into new production lines for leading-edge nodes. Of note, leading-edge nodes require many more process steps, and therefore limit the amount of wafers that can get through the production line.
Therefore, once memory demand returns to a more normal level, memory-makers won't necessarily be able to just "turn on" supply at the drop of a hat, since that equipment has already been redeployed. Thus, there appears to have been a permanent "reset" lower in memory industry wafer supply.
Is the "bust" setting up a boom?
It's a familiar refrain for cyclical stocks, as the boom in the pandemic years created the bust today. But could today's bust be sowing the seeds of an outsized boom in 2024 and 2025?
The two factors are supply and demand. With the damage done to the industry and equipment redeployed to leading-edge nodes, it will be difficult, time-consuming, and expensive for the memory suppliers to add more capacity. And if AI-fueled demand accelerates and/or sales for personal electronics and EVs recovers, demand could well exceed the industry's capacity, which has been reset lower.
Barring an even worse demand destruction than last year, which seems hard to imagine, memory companies should therefore see accelerating profits over the next year-plus.
