Why MU could be the smartest semiconductor play in the market

January 16, 2019

Why MU could be the smartest semiconductor play in the market

For the last several days, I’ve been focusing on the semiconductor industry. That’s because as the market has tested bear market levels, semis have slid further than most other industries the market. That decline represents risk, because the almost overwhelming sentiment about semiconductors seems to be more and more bearish. I also think, however, that if you filter through all the angst and anxiety of that bearishness, you can find some interesting opportunities.

In previous posts, I’ve spotlighted stocks like KLAC and LCRX, companies that provide much of the equipment and fabrication solutions that the semiconductor industry relies on. I like the idea of working with suppliers quite a lot, and I think those are some smart ways to mine good long-term, value-oriented opportunities in a bearish market. Another smart approach is to focus on companies in an industry or sector that posses significant competitive advantages to everybody else.

I think Micron Technology (MU) is a good example of an industry leader with a major competitive advantage. Despite intense competition, MU remains the unquestioned king of the hill in the memory space. This week that fact only became even more prevalent when the company announced a $1.5 billion dollar deal to purchase Intel Corp’s (INTC) share of the IM Flash joint venture that was launched more than a decade ago for $1.5 billion. The market seems to view that move favorably, as it gives the company complete autonomy in the operations of a segment that has helped drive the company’s growth in solid state memory storage. 

While there are a number of stocks in the industry that think are also very interesting, MU’’s industry leadership, along with its incredibly solid fundamental profile are the primary reasons that I think this company is better positioned than the competition to weather whatever storms the market blows its way over the next few years. When you add to that the fact that the stock is down about 47% since the summer of 2018, you get a value proposition that I think is very hard to ignore.

Fundamental and Value Profile

Micron Technology, Inc. (MU) is engaged in semiconductor systems. The Company’s portfolio of memory technologies, including dynamic random-access memory (DRAM), negative-AND (NAND) Flash and NOR Flash are the basis for solid-state drives, modules, multi-chip packages and other system solutions. Its business segments include Compute and Networking Business Unit (CNBU), which includes memory products sold into compute, networking, graphics and cloud server markets; Mobile Business Unit (MBU), which includes memory products sold into smartphone, tablet and other mobile-device markets; Storage Business Unit (SBU), which includes memory products sold into enterprise, client, cloud and removable storage markets, and SBU also includes products sold to Intel through its Intel/Micron Flash Technology (IMFT) joint venture, and Embedded Business Unit (EBU), which includes memory products sold into automotive, industrial, connected home and consumer electronics markets. MU’s current market cap is $38.1 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings grew by 21.5%, while revenues increased by a little over 16%. Those levels are lower than in recent quarters, and the company has attributed some of that decline to trade concerns and tariffs, which means that could continue to be a headwind this year. In the last quarter, in fact, earnings actually decline a little over -16%, while sales dropped by -6%. Even with the price pressure that are attributed to trade, ongoing competitive pressures, and slowing demand versus supply, the company operates with one of the biggest margin profiles that I’ve seen in the marketplace, with Net Income running at a whopping 47% of Revenues for the last twelve months, and 42% in the last quarter.
  • Free Cash Flow: MU’s free cash flow is very healthy, at more than $8.9 billion. That translates to an outsized Free Cash Flow Yield of 23%.
  • Debt to Equity: MU has a debt/equity ratio of .11. This number reflects the company’s manageable debt levels, and has dropped over the last two quarters from .2. The company’s balance sheet indicates cash and liquid assets are a little over $5 billion versus debt of about $3.7 billion.
  • Dividend: MU does not pay an annual dividend, which is the norm for most tech stocks.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MU is $30.99 per share, and has increased from $25.45 per share two quarters ago. That number also translates to a Price/Book ratio of 1.09 at the stock’s current price. Their historical average Price/Book ratio is 1.98. That suggests the stock is trading right now at a discount of more than 80%, and that puts the stock’s long-term target above $61 per share. That might sound pretty ambitious; and while the stock’s Price/Cash Flow ratio offers a more conservative 57% upside, that puts the stock’s long-term target price range between $53 and $61 – which is very nice no matter how you consider it.

Technical Profile

Here’s a look at the stock’s latest technical chart.

  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend since last May of last year to its trend low in December; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. The downward trend is clear and obvious, but the stock has seen some pretty solid bullish momentum since the end of 2018, rallying a little over 7% year to date. The stock has dropped back a couple of dollars since the end of last week, and could retest its low around $28 per share; however a pivot back to the upside anywhere between the stock’s current price and that low, with a push above $37 would mark the first step in a short-term upward trend that would see the stock test its next resistance at the 38.2% resistance line around $42 per share. If the stock does break below that support at $27, its next likely support level is around $23, which is a price level the stock last saw in the beginning of 2017.
  • Near-term Keys: The truth is that right now, a short-term bullish trade on MU is extremely speculative, no matter whether you want to buy the stock or work with call options. A break above $37, however should be taken as a solid bullish signal, and could open the way to a pretty solid bullish swing or momentum trade with a short-term target at around $42 per share. Treat a break below $28 as a signal to think about shorting the stock or to work with put options. If, like me, you think the competitive advantage and strong fundamentals offer a terrific value proposition, however, the stock is already trading at a very nice price.