micron (NASDAQ: MU) is a semiconductor stock that hasn’t kept up with the rest of the pack. While other names like Nvidia (NVDA) or AMD (AMD) have returned multiples of their stock prices during the Over the past few years, MU finds itself barely higher than it was four years ago. The stock has struggled to pull off a multiple expansion due to the cyclicality of its business as investors constantly wonder when earnings will peak. The key to the upside over the next five years is if the company can rewrite its history into a history of strong cash flow over cross-cycle periods. Trading at less than 7.5 times forward earnings, the current valuation appears to reward shareholders willing to take that leap of faith. A closer look at free cash flow reveals that it’s not such an easy decision to buy stocks.
MU share price
After falling 36% at the start of the year, MU finds itself trading around $72 per share.
That stock price puts it within 20% of where it was four years ago, marking a stunning underperformance for a company that has significantly improved its balance sheet and cash flow structure.
Key Metrics for UM Actions
MU derives the majority of its revenue from the sale of DRAM and NAND chips. MU experienced solid growth in each of these segments over the past quarter.
During the quarter, MU generated $3.6 billion in cash from operations and spent $2.6 billion in capital expenditures, generating free cash flow of $1.03 billion. The company spent $408 million of that on stock buybacks and launched a small $0.10 dividend per share.
The company ended the quarter with $4.9 billion in net cash and $14.4 billion in cash, representing the strongest balance sheet position in years. Looking ahead, MU expects approximately $8.7 billion in revenue, representing 17% year-over-year growth.
What are the Micron technology enablers to watch out for?
There are several potential catalysts on the horizon for the MU stock. More important is whether the memory industry can evolve from its cyclical history to become more of a secular growth story. We may be seeing this transformation as the company sells into attractive end markets such as data centers, 5G and automotive industries.
MU has worked hard to reshape its history. Over the past few years, MU has transformed its balance sheet from net leverage to net cash.
The strong balance sheet position and improved cash flow structure enabled the company to commit to returning 50% of free cash flow cycle-to-cycle to shareholders through share buybacks. shares and dividends.
MU is taking the right steps to execute the sentiment shift in stocks and I expect the stock to reap the rewards over time, although it’s unclear if this is the right time.
Where will Micron Technology’s stock be in 5 years?
Wall Street consensus estimates predict earnings will continue to grow before peaking in 2024.
Yet, arguably the most important component of the stock market outlook is not earnings forecasts, but rather stock market sentiment. The cyclicality of MU’s business has historically put off many investors, but MU has shown the ability to increase cash generation over a 4-year moving average.
Although earnings can fluctuate from year to year, MU has shown that multi-year cash flow increases over time. Will Wall Street buy the story?
Is MU stock a buy, sell or hold?
Historically, buying MU stocks was all about timing the peaks and troughs. At first glance, it might seem like the stock is a lot with the PE ratio hovering in the high numbers.
But cyclical stocks tend to have significant volatility in underlying earnings, and MU is no different, as seen below:
An easy way to analyze valuation while adjusting for cyclicality is to look at price versus multiple sells – by focusing on sells, the multiple is not as heavily impacted by operating leverage. We can see below that MU is actually trading near all-time highs in terms of valuation.
Still, it could be argued that MU shares should trade at even higher multiples from here based on net cash balance and shareholder-friendly capital allocation policies. I think it’s too early to assume that MU will start trading at secular growth type multiples, but maybe some might think that 7.5x earnings is too conservative. It’s possible that global demand for memory chips could skyrocket, propelled by the tailwinds of secular growth in sectors such as data centers, 5G and the Internet of Things in general. It is possible that the increase in demand could eventually offset the historical cyclicality of the memory chip market. If that were to happen, then I could see MU trading up to 10x-12x earnings, which is up to 70% multiple expansion potential. I hesitate to assign a higher earnings multiple as I expect some doubts to persist even in the medium term.
Now let’s explain why this kind of thinking can be wrong. MU has historically reinvested cash from operations into capital expenditures and has been unable to significantly increase free cash flow over the long term.
Based on MU’s own numbers, the company generates just over $4 billion in free cash flow over 4 years. On an annualized basis, this represents a free cash flow yield of just 2.4%, well below the current earnings yield of 13%. This distinction is important because dividends and share buybacks are paid out of free cash flow, not earnings. The company has a strong net cash balance, so it doesn’t need to direct free cash flow towards paying down debt, but with the stock trading at a cash flow yield 2.4% Implied Available, Does It Really Matter? MU is often viewed as a value stock, but current shareholder returns do not validate that sentiment. Above, I argued that the multiple could reach 12 times earnings if the company can prove that it benefits from some secular growth tailwinds. However, our free cash flow analysis shows that the company might actually need such a change just to justify the current stock price. The company has increased its 4-year free cash flow by approximately 500% over the past seven years, but will need to continue to increase its free cash flow in the future. Even if the company increases its free cash flow by another 200%, the free cash flow yield will still be around 7.2%, which is still well below the implied 13% earnings yield. The current valuation is a value more representative of a growth stock, even if MU is often considered a value stock.
That’s what I think is the problem at play here: while the stock looks cheap on an earnings basis, the stock is anything but cheap on a free cash flow basis, and we’re already using the high free cash flow figures of recent years. Sure, a shift in sentiment alone might be enough to spur the multiple expansion, but is that so likely given the weak free cash flow yield? In my opinion, multiple expansion will occur primarily when the company increases dividends and share buybacks, as that would be the most obvious way to get rid of the cyclical status of stocks. Yet these dividends and share buybacks won’t be as significant until the yield on free cash flow increases, and that might not be so easy to achieve – we just saw above that an increase 200% free cash flow isn’t quite enough to reconcile free cash flow with earnings. Over the next five years, I consider it unlikely that the stock will be able to achieve the significant change in sentiment – or at the very least, the current free cash flow yield of 2.4% does not compensate shareholders enough to take the risk. I believe stocks are owned and advise investors against buying stocks based on earnings performance.