Why fast-rising Micron could still go higher

A bold bet to change industry supply dynamics looks primed to reap increasing rewards. Here's what to look for.

By StreetAuthority Jun 5, 2014 12:04PM

Image: Circuit Board © Datacraft Co Ltd, imagenavi, Getty ImagesBy David Sterman, StreetAuthority

The semiconductor industry is notorious for repeated boom-and-bust cycles.

Supply and demand for chips can have a rapid impact on industry profits. For example, when too many chips hit the market, a rapid price plunge can ensue that wipes all profits for that cycle.

It's no wonder such stocks deserve low price-to-earnings (P/E) ratios.

Memory chip maker Micron Technology (MU) is the poster child for such peaks and valleys: Micron has lost money in four of the past seven fiscal years, racking up a cumulative $1 billion in operating losses in that time.

Still, Micron's aggressive shift in 2011 away from deeply cyclical DRAM (dynamic random-access memory) chips and toward increasingly popular flash memory appeared poised to give a sharp boost to sales and boost to profits, and a path to consistent profitability. Roughly three years ago, I wrote that the advent of tablet computers, with their need for ample flash memory, would help finally push this stock out of doldrums.

Fast forward to 2014, and Micron is now earning a record $3 a share annually, and shares are up 370 percent since I profiled them back in 2011. Micron also got a sharp boost by acquiring an Asia-based rival, which helped bring much more rational industry production capacity in an industry known for chronic overproduction. I discussed this issue in May 2012, and thought shares had upside to $12.

As it turns out, the two drivers noted above were much more powerful than I had anticipated, and shares took off like a rocket:

Perhaps the most remarkable aspect of this rebound: It's only halfway done.

If current and future industry conditions continue to play out favorably, shares could wind up at $50 before they are done. And much of that upside stems from the company's previous actions.

Micron's acquisition of Elpida's assets out of the Japanese bankruptcy court process is still being digested, and it's becoming clear that Micron will not only have succeeded in reducing the industry's oversupply dynamics (as part of Elpida's capacity has been shuttered). But the assets from that deal that Micron is using cost the company just 25 cents on the dollar compared with what it would have had to pay for newly built capacity.

These numbers are important because 70 percent of the acquired capacity is tied to the lower-margin DRAM market, so squeezing profits out of this lower end of the memory market is crucial. (The other 30 percent focuses on flash, which makes Micron an even stronger player in that niche.)

Analysts at Drexel Hamilton believe that the "new Micron" can generate 45 percent gross margins by fiscal 2016.

Micron is now using its industry strength to more aggressively pursue industry partnerships. It is rumored to be partnering with Intel (INTC) in the development the next generation of Flash, known as Flash 3D. Right now, the current iteration is known as Flash 2D and is currently dominated by rival Sandisk (SNDK). The 3-D chips allow for more transistors to be packed on a smaller footprint, and are roughly 20% percentcheaper to build. "If MU succeeds on its public aim as first into 3D, SNDK's 25 percent cost advantage would quickly erode," writes Drexel's Rick Whittington, a well-respected veteran chip-industry analyst.

And a shift to cut manufacturing costs could take Micron's profits nicely higher. Whereas Micron has worked hard to achieve blended gross margins in the mid 40s, Whittington now thinks a multi-year goal of 50 percent gross margins "looks conservative." Said another way, Micron's projected earnings per share in the $3 range for this year could exceed $4.25 a share by fiscal 2015, and $5 a share by fiscal 2016, according to Whittington. He figures shares will trade up to 10 times those profits, or $50.

Risks to consider: Memory prices have been firm for the past few years, in large part to smaller industry capacity, but other factors such as slowing demand for tech products that use memory could lead this cyclical industry back down in the cycle again.

Action to take: Micron continues to glean benefits from its bold acquisition that has not yet been fully appreciated by the analyst community. Yet in coming quarters Micron appears set to deliver a string of robust EPS growth results as it continues to reduce excess costs from the recent big acquisition. If you want to better understand current industry trends, Micron will hold a quarterly conference call later this month.



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