Micron (NASDAQ:MU) reported their FYQ1'15 earnings results on January 6th. While Micron reported EPS of $0.97 for the quarter beating Street consensus estimates by $0.05, the second quarter guidance was disappointing, missing Street EPS estimates by almost $0.08. Note that Micron does not guide EPS estimates, but communicates enough information for you to calculate a range for EPS.
In the first quarter Micron hit on almost all cylinders. DRAM pricing came in slightly better than consensus estimates. Operating expenses came in below the company's original guidance. Bit production also grew as expected. With the addition of an extra week in the quarter, revenues and EPS hit all-time highs. The only negative data point during the quarter was a weaker NAND pricing environment and continued weakness relative to peers in Micron's NAND products. Micron is still in the middle of qualifying it's NAND products to markets which could take better advantage of its technology. Right now they are competing in the low-end market with higher-end products causing Micron to earn close to 10% less gross margins than its peers Samsung and Sandisk/Toshiba.
What Happened In The February Guidance?
Unfortunately for investors, Micron's second quarter 2015 guidance was less than stellar. However, doing a little bit of digging beneath the surface results yields a much brighter picture. Let's go through each of the issues below:
1. The extra week in the November quarter
A number of Sell-side analysts had incorrectly modeled flat revenues for the second quarter while not taking into account the extra week they had in the first quarter. Doing simple math (14 weeks in Q1 vs. 13 weeks in Q2) means that Micron had a natural 7.6% headwind to revenue just due to accounting reasons.
2. Bit growth guided flat in February and below market for Fiscal 2015
As semiconductors become more difficult to manufacture, technology transitions in the memory space have become more difficult. This is most obvious in the slowdown of supply growth over the last few years. While supply has grown at 40 – 50% per year historically in 2014 and beyond, the industry is predicting low-20% supply bit growth. As transitions become more difficult, there will often be quarters where bit growth could be flat for some suppliers as they try to bring in new equipment. February happens to be that quarter for Micron.
However, this mathematically means that the May quarter will have higher than average bit growth. For Micron to achieve its high-teens bit growth estimates for 2015, this would have to be the case. As opposed to an average 3%-4% qtr/qtr bit growth in DRAM, we believe Micron could see high-single digit growth, a large tailwind in the 3rd quarter.
Lastly, weaker bit growth means a stronger supply/demand environment. Lower supply bit growth in 2015 means that pricing should remain stable in both the PC and Mobile handset markets which is not only good for the industry, but should be very accretive to Micron earnings.
3. Pricing is down low-single digits in the February quarter
Lastly Micron guided to a low-single digit decline in DRAM and NAND pricing for the Feb quarter. While this might seem negative at first, it is a huge positive in a seasonally weak quarter. The Feb quarter represents the weakest demand quarter of the year for PCs, servers, and smartphones, three of Micron's largest markets. A low-single digit price decline is significantly above seasonal declines, which have been as high as mid-teens declines in years past. Last year was a unique situation where one of Micron's key competitors had a factory fire.
Why Micron Is A Buy Now
The pull back in Micron's stock price over the last week represents a tremendous opportunity to buy a stock that I believe is worth $45- $48 in the next twelve months. There are a few catalysts this year that should lead to this price appreciation:
- Bit growth should accelerate into the 2nd half: As mentioned above, May quarter bit growth should be above average given the flat bit growth in the Feb quarter. Additionally, Micron's subsidiary Inotera has delayed the majority of their supply additions to the back half of 2015. This will also meaningfully increase bit growth, ultimately meaning more revenues for Micron.
- Pricing will only get better: The 2nd quarter is the weakest demand quarter for the industry. By the summer OEMs start to ramp up PC and smartphone builds for the back-to-school and holiday seasons. Pricing should be stable / up from here.
- Demand is going to take a step function up this year: There have been multiple rumors in the market citing a move from 1GB to 2GBs of DRAM in the next model of the iPhone. Given the large number of iPhone units along with its ability to drive competitors to copy its lead, this could mean a larger increase in DRAM demand in the 2nd half, further constraining an already tight market.
- Buyback on the come: Micron has a $1Bn stock buyback authorization outstanding which it has used none. The company has also promised to be more aggressive going forward by potentially announcing additional buybacks.
- NAND margins to improve by up to 10%: As stated above, Micron has underperformed its peers due to a mismatching of technology versus customer needs. Remember they are selling high-quality NAND products to lower-quality markets, effectively hurting their gross margins by up to 10%.
With today's "miss" in second quarter guidance, Street numbers have come down for the second half of fiscal year 2015. Consensus estimates predict $0.91 in the 3rd quarter and $1.05 in the 4th quarter. Assuming 5% qtr/qtr bit growth for the next 2 quarters and modest ASP increases going into the back half of the year, Micron is capable of doing as much as $1.25 of EPS. Add on to this the possibility of significant share buybacks and an improvement in core NAND margins and I can see Micron doing up to $1.40-$1.50 of EPS in the latter half of the fiscal year. With the company trading in the low-$30s, the company is trading as low as 6x our FY2016 EPS.