Micron Technology, Inc. (NASDAQ: MU) has been an attractive investment opportunity over the past few years, as it has benefited from a number of coinciding trends. From accelerating cloud computing and chip shortages to high memory demand for mobile devices and graphic products.
However, even as the company’s memory and storage products rode the wave of digitalization, Micron still underperformed the semiconductor industry as a whole.
To some extent, Micron’s performance is comparable to Samsung and SK Hynix since they are two direct peers when it comes to memory and storage space. However, focusing entirely on this semiconductor sub-segment would have resulted in much lower returns over time. Therefore, throughout this article, I will use an expanded peer group of large publicly traded semiconductor stocks.
That said, Micron shareholders recently received good news following the company’s announcement of a quarterly dividend.
Not only that, but the dividend has also seen a significant increase recently, which has raised hopes that the stock will turn into a solid dividend play on top of the high growth potential.
Finally, the company’s low multiples made the investment proposition even more attractive by giving it a significant margin of safety.
The compelling fundamentals of Micron
On the surface, it sounds too good to be true. Micron currently has a dividend yield of nearly 1%, with annual payments growing at a rate of 15%.
At the same time, the company’s revenue continues to grow at double-digit rates, while margins are at all-time highs and relative to industry averages.
Last but not least, MU is trading at multiples not found anywhere else in the large-cap semiconductor space. Using the non-GAAP P/E ratio as an example, MU is now trading at 7x next year’s earnings (see below).
The narrative around the future size of the memory and storage solutions market only further sweetens the deal as demand from the data center, industrial and automotive sectors is expected to grow at rates above 20% on an annual basis.
In a nutshell, on the surface, Micron appears like a unique opportunity – a high-growth, profitable company that also trades at ridiculously low multiples and offers a growing dividend. However, as we dig deeper into Micron’s business model and consider the highly cyclical nature of the business, Micron’s low multiples seem justified. Additionally, the current dividend is not something long-term investors should count on.
What should investors know about Micron Technology’s business?
It’s no secret that in terms of revenue, DRAM accounts for about three-quarters of Micron’s business.
However, DRAM’s footprint is even more significant on the company’s overall valuation. The reason for this is expected future growth on the one hand and profitability (or return on capital more broadly) on the other. For starters, over the past 9 months, NAND storage revenue was around $6.1 billion.
The SBU (Storage Business Unit) segment accounts for about half of this number (see below), leaving about $2.5 billion in NAND sales for the MBU (Mobile Business Unit) and EBU (Embedded Business Unit) . The CNBU (Compute and Networking Business Unit), on the other hand, only includes memory-related products.
That said, the SBU is now barely profitable with significant losses before the high demand following the pandemic. The other business units primarily sell memory solutions and as such are Micron’s main profit drivers.
Therefore, it is reasonable to conclude that DRAM is much more important to MU’s overall valuation and future returns. However, demand for DRAM solutions is also more volatile compared to storage and Micron has little pricing power in a market dominated by the two South Korean giants – Samsung and SK Hynix.
All of this is clearly illustrated in the company’s annual report, under the heading of risks, where the volatility of selling prices is noted as a major risk.
The impact of changing average DRAM selling prices on Micron’s margins is also evident when we reconcile the table above with the graph below. In 2019 and 2020, the average DRAM selling prices decreased by 30% and 34% respectively, and as a result, MU’s operating margin decreased from nearly 50% in 2018 to 14% in 2020.
Therefore, as exciting as the story of the future may sound, the reality is that slight shifts in aggregate demand and average DRAM selling prices could have profound implications for Micron’s profitability.
Finally, investors should keep in mind the political risk associated with the geographic positioning of Micron’s long-term assets.
The income gap
By far the biggest risk to Micron shareholders and the recently initiated dividend payments is the highly cyclical nature of the industry and the commoditized nature of memory and storage products. Although management has recently pointed out that some end markets for the company’s products are more stable, Micron’s earnings remain highly cyclical.
Just looking at stock price variance and overall market exposure via beta coefficient, Micron sits near the top of its larger peer group (see below).
Cyclicality is also a key reason why Micron rarely trades at more than double its equity book value, even though asset returns have improved significantly in recent years.
* based on operating income and total assets
Additionally, MU’s margins are highly dependent on global demand and shipments of silicon materials. As the industry is capital intensive and cyclical in nature, manufacturers are often constrained in terms of capacity during times of high demand. This in turn provides a significant tailwind on prices and therefore on margins. Investors should keep in mind, however, that the reverse is also true and that margins could deteriorate rapidly even with a slight slowdown in demand.
This is why simply extrapolating very recent trends into the future could lead to disastrous results.
Although semiconductors have become part of every aspect of our daily lives, demand remains closely linked to the evolution of real GDP figures.
* from Q1 2000 to Q4 2022
That said, Micron’s earnings in the coming years will remain volatile, regardless of the current narrative. Of course, a global recession and slowing demand are far from certain, however, investors shouldn’t expect Micron’s earnings volatility to go away. Therefore, while annual dividend payouts of approximately $500 million are well covered by the company’s free cash flow at this time, long-term investors should not count on consistent dividend growth over the long term. term. On the contrary, the dividend is likely to be suspended indefinitely during the next downturn in the economic cycle.
Micron Technology is undoubtedly one of the leaders in volatile and non-volatile memory. As digitization trends have accelerated in recent years and demand for DRAMs has exploded, the capacity-constrained industry has benefited from both volume and price increases. However, given the capital intensity and highly cyclical nature of the industry, profit margins are at significant risk over the next few years. This is why the current low multiples are probably justified, as they take into account all the risks associated with a potential slowdown in the economic cycle. Finally, Micron’s dividend payouts are unlikely to increase steadily beyond the near term and the recently announced 15% increase is not indicative of the future.