Micron Technology (MU)

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Mobile Strength Still Makes Micron A Value Investment

Jul. 4, 2015 2:09 PM ET | 49 comments | About: Micron Technology Inc. (MU)

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MU over the next 72 hours. (More...)

Summary

Micron’s Mobile Business Unit continues to be an area of strength and consistency in 2015, delivering $296m of net income in the quarter.
Micron’s Compute Networking Business Unit, which is largely comprised of PC sales, delivered $1.514B, of revenue which represents a decline of 20% from the trailing six-quarter average of $1.89B.
Micron remains a value investment with potential upside of $25 over the next 12 months largely dependent on gross margin stabilization and improvement.
Micron’s Embedded Business Unit continues to deliver consistent revenue and net income contributions. The unit delivered $98m of net income or a 10% increase over the trailing six-quarter average.
Micron’s Storage Business Unit remains stuck in the mud and desperately needs Micron’s relationship with Seagate to bear some fruit.
Micron (NASDAQ:MU) recently reported earnings that came in below street expectations that sent the stock price crashing nearly 20% in one day. The PC weakness on top of MU's own manufacturing issues resulted in gross margins of 31% vs. my expectations of 34.5%. On the positive side MU's gross margins could improve at any given time. The bad news however is that the timing of such an event remains fairly uncertain. My earnings expectations for Micron in FY16 have been trending down over the past several quarters and I recently took a hatchet to EPS estimates and Micron's fair value.

Image Source Wall Street Forensics (click link below for images/charts)

I've put together a post Elpida acquisition historical performance (seven quarters of data) that includes Micron's four core business segments and a snapshot of Micron's overall business performance. Past performance is not indicative of future performance but it does provide us with some critical data elements to understand trends and business strengths. I've provided my forecast for the coming five quarters where I felt it was applicable in the various charts below.

Images Sourced from Wall Street Forensics (click link below for images/charts)

Micron's Compute Networking Business Unit (CNBU), which is largely comprised of PC sales, delivered $1.514B of revenue which represents a decline of 20% from the trailing six-quarter average of $1.89B. In terms of net income derived from PC sales the story gets even worse with Micron reporting just $266m in net income, down from the trailing six-quarter average of $516m.

Micron's Mobile Business Unit (MBU) continues to be an area of strength and consistency in 2015. In fact Micron's Q3 results marked the first since in its post Elpida acquisition history that MBU delivered more net income than CNBU ($296m versus $266m). MBU accounted for $938m in sales representing an increase of 9% above the trailing six-quarter average of $862m. In terms of net income MBU delivered 296m of net income or a 64% increase over the trailing six-quarter average of $180m.

Micron's Storage Business Unit (SBU) remains stuck in the mud and desperately needs Micron's relationship with Seagate (NASDAQ:STX) to bear some fruit. Absent of Micron's relationship with Seagate I would question why Micron even plays in the storage business that has contributed a diminishing return to shareholders over the past six quarters and has turned negative over the past two quarters. SBU accounted for $901m in sales representing a decrease of 5% above the trailing six-quarter average of $946m. In terms of net income SBU delivered negative ($33m) compared to the trailing six-quarter average of positive $72m.

Micron's Embedded Business Unit (EBU) continues to deliver consistent revenue and net income contributions. EBU accounted for $483m in sales representing an increase of 7% above the trailing six-quarter average of $453m. In terms of net income EBU delivered 98m of net income or a 10% increase over the trailing six-quarter average of $89m.

Micron's fundamentals should begin to improve over the coming quarters but it may be as long as 6 to 9 months for things to improve. PC sales and margins should begin to stabilize, mobile should continue to be the rock that Micron can count on each quarter and Micron's anemic storage business in conjunction with Seagate should begin to bear some fruit over the next 6 to 12 months. Micron's management is converting a lot of capacity from 30 nanometers to 20 nanometers, which has negatively impacted DRAM gross margins and likely negatively impact gross margins throughout the first half of FY 2016. My expectation is that margins will remain challenged through the first half of FY2016 and possibly linger throughout FY 2016.

The uncertainly of MU's operational turnaround will significantly hamper EPS in FY 2016 and also make it fairly difficult to model. Unlike the previous six quarters MU's gross margins (31% in Q3) failed to exceed 32% and fell out of the recent 18-month range of 32 to 36%.

The pricing and gross margin concerns were even apparent after reviewing the revenue split between DRAM and NAND. In previous quarters DRAM represented close to 68% while NAND came in at 28%. During Micron's most recent quarter DRAM came in at 61% of revenue and NAND represented 32% of revenue. DRAM gross margin fell from a low 40% to upper 30% as the company was able to reduce manufacturing costs by 6% but was unable to cover the 10% decrease in selling prices in Q3. Management's guidance for Q4 will result in additional gross margin compression for DRAM driven by further declines in ASP that will be partially offset by production cuts.

I cut my FY16 EPS estimate to $2.50 for MU and dropped my 12-month fair value price target from $42.50 to $25.00. My expectation is that Micron will trade relatively flat over the coming six months before making a significant jump over the second half of Micron's FY16 (April to October 2016) in anticipation of higher gross margins and quarterly EPS contributions.

As you can see from the chart below Micron's share price is highly correlated to gross margins. Micron's revenue is relatively flat over the past two years, which means gross margins play a heavy role in determining earnings power. If Micron's revenue was consistently growing year-over-year gross margins would play a less significant role in determining Micron's fair value.

Image Source Wall Street Forensics (click link below for images/charts)

One positive for long-term investors is that a slight improvement in gross margins will almost instantly push MU's earnings power north of $0.75 on average per quarter. At this point I'm circling my calendar for April 2016 as the earliest date MU could possibly change its tune and offer an upbeat outlook. In the meantime, shares remain a value investment for shareholders worth up to $25.00 per share.
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http://seekingalpha.com/article/3302385-mobile-strength-still-makes-micron-a-value-investment

Back in at $18.65. Been a good base here -- so far!

MU