Micron Technology (MU +4.84%) shares have enjoyed an amazing run in the past year after tucking in gains of nearly 150%. Many investors now fear that the shares have run too far and are close to the end of their fairy tale run. Falling prices of DRAM and NAND chips in the second quarter also have investors concerned that Micron might soon start facing intense margin pressure.
But, there are some very compelling reasons to believe that Micron shares can defy widely held expectations and actually tuck in further gains, both near-term and long-term. This possibility is supported by stabilizing DRAM and NAND prices and margins, and because the company's shares are relatively cheap compared to peers such as SanDisk, Western Digital (WDC 0.57%), EMC, and NetApp (NASDAQ: NTAP).
Cheaper than peers
The perception that Micron shares are expensive is inaccurate, especially considering the company's strong growth potential (both revenue and EPS growth). Compared to peers, Micron shares are actually trading at a bigger discount to their fair value.
|
Company Name |
Forward PE |
5-Year PEG |
Forward EV/EBITDA |
5-Year Forward EPS Growth |
3-Year Historical ROIC |
Share Price/Fair Value Estimate |
|---|---|---|---|---|---|---|
|
Micron |
7.8 |
1.1 |
3.7 |
19.8% |
(0.8%) |
74.7% |
|
NetApp |
13.0 |
1.5 |
5.3 |
17.1% |
(4.1%) |
76.3% |
|
Western Digital |
11.1 |
1.7 |
5.3 |
13.1% |
51.3% |
103.5% |
|
SanDisk |
13.6 |
1.7 |
7.0 |
11% |
110% |
89.2% |
|
EMC |
13.7 |
1.5 |
7.3 |
12.9% |
197% |
83.2% |
|
Peer Median |
13.3 |
1.6 |
6.2 |
13% |
80.1% |
86.2% |
|
Industry Median |
13.7 |
1.7 |
7.2 |
13% |
31.3% |
88% |
From the chart above, it's clear that the valuation of Micron shares is still within a healthy range.
Micron's revenue has largely benefited from its Elpida Memory acquisition, making the combined entity the second-largest DRAM chipmaker. The benefits of the merger have exceeded expectations, and greatly boosted Micron's revenue and earnings. Micron's revenue grew 97.6% over the last 12 months, compared to the industry average of just 3.4%, and the company's earnings grew an astounding 317.8%.
Revenue from smartphone and tablet NAND memory chips has also been growing at a robust pace. These factors have helped to keep the shares' valuation in check, even as prices soared.
Stabilizing DRAM and NAND prices
DRAM chips account for 40% of Micron's sales, NAND flash contributes 45% of revenue, while NOR flash chips in 15% of sales.
Excess manufacturing capacity, coupled with soft market demand, lowered the profitability of memory chips in 2012. But, the DRAM industry underwent extensive consolidation in 2013, and the remaining players have managed to keep the supply/demand balance good, for what is essentially a commoditized product. DRAM prices were mainly flat in the first quarter of the current fiscal year.
NAND flash prices fell 6% and 18% in the first quarter and second quarter, respectively. Micron predicts that prices for both DRAM and NAND will fall in the low single-digits for the second half of the year.
DRAM manufacturers have increasingly been reallocating capacity away from commodity DRAM. As a result, DRAM prices increased in April; mainstream DDR3 4GB module prices hit a high of $27 in April, a 13% monthly increase.This was the biggest rise in DRAM prices since prices of the commodity begun rising five months ago.
Two-GB modules also sold well, and 2GB DDR3 saw a 9% price increase. According to DRAMeXchange, a division of TrendForce, the transaction volume was also impressive, which might offer support for further price increases during the current quarter.
TrendForce says that the highest mobile and server DRAM ASPs in the current fiscal year are likely to be achieved in the current (second) quarter. DRAM prices have been rising, while NAND prices have been coming down in the last few months.
It seems safe to assume, then, that prices won't change much in the second half of the year, possibly even in the next few years. Micron's profit margin clocks in at 34%. If industry margins went up to, say, 50%, the existing players might start increasing their capacity, while new players might be tempted to jump in, reversing recent price gains. Stabilizing margins would help to prevent this from happening.
Are there other good buys?
NetApp shares have fallen about 13% year to date, and 22% from their January high of $45.85. Shares are also trading at a considerable discount to their fair value, but are they a good buy?
Although shares are cheap, it would be better to give them a wide berth. NetApp seems to be struggling to compete against EMC, the market leader in storage solutions. The company's revenue from OEMs declined 34% last quarter, which is very worrying. To make matters worse, IBM recently announced that it will stop reselling NetApp products and instead start selling its own, a move that is likely to create even more challenges for NetApp.
Conversely, Western Digital looks like a good buy. The company enjoys a strong gross margin of 37.35% and has a low debt-to-equity ratio of 0.28. However, shares are up almost 42% year over year and are currently trading at a small premium to their fair value. Although Barclays upgraded shares to a buy, it's advisable to wait for a pullback of perhaps 5%-10% before buying.
Foolish bottom line
Micron shares are not too expensive, despite having made a good run in the past year. Shares still look like a good bargain, and now might be a good time to buy.
