Bullish on Micron
May 31, 2018
The broader markets remain subdued on Thursday due to worries of a trade war with close allies Canada, Mexico, and the European Union. Concerns over retaliatory actions and no revisions to the North American Free Trade Agreement are causing selling in many industrials and exporting companies, and conversely, the market is buying tech stocks like Facebook (FB), Alphabet (GOOGL), Amazon (AMZN), Nvidia (NVDA), and PayPal (PYPL) that do not rely on exports. And how could we not mention Nucor (NUE), the biggest beneficiary of steel tariffs.
We are looking to buy into this selloff, however, we are not rushing into anything because the trade war narrative (especially as we head into the weekend) may cause some extended uneasiness.
One tech name that is not rallying with its broader group is Micron (MU). The cause of the MU's sharp decline? On Thursday, analysts at Morgan Stanley downgraded their rating on MU to "Equal Weight," facilitating a roughly 8% decline in the stock based on the time this was written. The analysts admitted that they may be early in their call, but they believe that most of the remaining upside has become priced in because of the stock's impressive move, and the DRAM pricing is still cyclical and near-term demand is not as strong as what others think. While the downgrade has certainly rattled investor today, we want to reiterate our view of Micron.
So why are we bullish on MU? We believe that the DRAM market has become much more secular in growth. Yes, historically it is cyclical in a nature, but this occurred during time where PCs dominated its market, and too much concentration in one area made it susceptible to boom/busts. And DRAM demand has greatly changed since then due to the notable increases in demand coming from data centers (think the cloud), as well as the adoption of smarter industrial equipment and vehicles, which autonomous driving represents a long-term tailwind in, not to mention the massive amounts of computing power required for artificial intelligence related functions, which are slowly making their way into every industry on the planet. It has also become much tougher for supply to come online. The chips have become much more complicated over time, causing less supply growth capability on a per wafer basis. Furthermore, capital intensity has increased, making it harder for companies to increase capacity and cause oversupply.
And the company plans to buy back a ton of stock. Now looking at the management's recent history you may wonder why they did a $1 billion secondary offering when the stock was in the low $40s in 2017, and now they want to buy back $10 billion of stock with the stock in the $50s. That is buy low, sell higher at first glance. But as Mehrotra explained, they raised cash in order to pay down Senior Secured notes and other outstanding debts that carried specific covenants (think binding agreements) that needed to be taken care of first. With those out of the way and management believing the company has healthy fundamentals, the Board authorized a program to buy back $10 billion worth of stock beginning in FY19 with plans to return at least 50% of free cash flow to shareholders. This is a major sign of confidence in the sustainability of earnings, and if there is a bit of a downtrend beginning next year like the bear thesis expects, we anticipate management will be right there buying up the stock.
After MU's monster run, it is not a complete surprise to see it cool down after an analyst provided a cautious tone. It serves as a lesson in why it is wrong to chase on a big move. And because we are still long-term bullish, we will let some of the "hot" money that rode the stock up almost 10 points since the analyst day flush out first, and then we would bless some small buying.