How US-China Trade Tensions Have Affected Micron’s Earnings
Micron and the US-China trade war
For the last three years, Micron Technology (MU) has been strengthening its foundations by improving its product mix and balance sheet, reducing costs, and executing advanced technology. These strategies have helped the company withstand the downturn more than peers. US-China tensions and the US trade ban on Huawei are pressuring memory demand.
In Micron’s fiscal 2019 third-quarter earnings call, CFO Dave Zinsner stated that the Huawei ban reduced the company’s revenue by $200 million during the quarter, and it had to write down $40 million in inventory it created specifically for Huawei. However, Micron reduced the 90% impact from tariffs by shifting its supply chain.
Micron maintains strong earnings in a downturn
In the third quarter of fiscal 2019, Micron’s revenue fell 18% sequentially to a more than two-year low of $4.79 billion due to lower DRAM (dynamic random access memory) and NAND (negative AND) prices, the Huawei ban, and slow demand from customers absorbing their elevated DRAM inventories.
In fiscal 2019’s fourth quarter, Micron expects memory prices to continue falling but more slowly, customer inventory levels to normalize, and demand to pick up. However, it expects these benefits to be more than offset by lost sales to Huawei, resulting in its revenue falling 6% sequentially to $4.5 billion during the quarter. In fiscal 2019’s third quarter, the company’s revenue fell 18%.
For Micron, a pure-play memory chip maker, profits are a product of memory prices, cost, and product mix. As memory is a commodity, its prices are governed by market demand and supply forces. Therefore, the company focuses on cost and product mix to improve profits.
In fiscal 2019’s third quarter, Micron’s non-GAAP gross margin narrowed by 1,100 basis points sequentially to 39%. Tariffs contributed 30 basis points of that decline, and underutilization charges related to Intel Micron Flash Technologies contributed 200 basis points.
Micron expects its non-GAAP gross margin to contract by another 1,000 basis points in the fourth quarter of fiscal 2019 as DRAM and NAND prices continue to fall. Although the US has threatened to impose tariffs on another $300 billion in Chinese imports, Micron could largely be unaffected as most of its products have already been tariffed. The company is still optimistic that AI (artificial intelligence), autonomous vehicle, 5G (fifth-generation), and IoT (Internet of Things) trends will drive demand for memory and storage in the long term.
Micron’s focus on costs and high-value solutions pays off
Micron has improved its EBITDA margin by 20 percentage points since 2016 by focusing on technology, cost competitiveness, and high-value solutions. These efforts have paid off, and Micron’s profits have improved more than competitors.
To compare, Micron’s operating margin narrowed by 1,300 basis points sequentially to 23% in fiscal 2019’s third quarter, whereas Western Digital’s (WDC) gross margin stood at 25.3%. The fact that Micron’s operating margin is close to the gross margin of a NAND competitor highlights Micron’s cost competitiveness and strong product mix.
Micron’s strategies to reduce production costs comprise two strategies: transitioning to cost-effective nodes, and investing in back-end packaging facilities and integrating them with front-end systems. Micron has reduced its cost gap with Samsung and other competitors by accelerating its transition to advanced nodes such as 1Z and 1Y DRAM. Every node transition reduces cost by ~20%. Micron is moving toward having fewer vertically integrated sites with assembly and test capabilities to gain greater control over quality, product customization, and production.
Micron has been shifting from being a commodity company to a memory solutions provider by investing in high-value specialized solutions such as automotive and enterprise memory. In fiscal 2019’s third quarter, more than two-thirds of Micron’s NAND revenue came from high-value solutions, keeping its NAND gross margin above 25%. In comparison, Western Digital’s NAND and HDD (hard disk drive) gross margin was 25.3% in its corresponding quarter, and Intel’s NAND business reported an operating loss in the first quarter.
This shift to higher-value NAND solutions helped Micron grow its global NAND market share by 110 basis points sequentially to 16.5% in the first quarter, according to DRAMeXchange.
Although Micron’s non-GAAP EPS fell 39% sequentially to $1.05 in the third quarter of fiscal 2019, they were well above Western Digital’s EPS of $0.17. Micron expects to report positive EPS of $0.45 in fiscal 2019’s fourth quarter, whereas analysts fear Western Digital could report a loss. As Micron has done pretty well compared with peers even during the downturn, its stock may be worth holding on to for the long term.
Micron’s DRAM business
Micron earns 64% of its revenue from DRAM. It is the world’s third-largest DRAM supplier after Samsung and SK Hynix, and the largest automotive DRAM supplier. In fiscal 2019’s third quarter, Micron’s DRAM revenue fell 18.6% sequentially to $3.06 billion as its ASPs (average selling prices) fell 20% and its volumes were unchanged. Micron’s DRAM ASP decline was lower than the industry’s DRAM price decline of 25%, according to DRAMeXchange. Micron’s DRAM ASPs are determined by DRAM market prices and its product mix.
Micron’s increase of 1Y DRAM’s contribution to its mix has brought cost benefits. It is also ramping up its 1Z DRAM production and expanding its cleanroom space to accelerate its DRAM transition.
Micron expects improved customer inventories to drive DRAM industry demand
DRAM, a device’s memory, is important as it determines its performance. Therefore, DRAM demand is not sensitive to prices. However, the DRAM market has faced oversupply since the second half of 2018 as demand fell in the PC, server, and graphics markets. Demand fell as customers moved to absorb excess DRAM inventories, which increased producers’ inventories.
In March, Micron expected DRAM industry bit demand to grow by a low-to-mid-teen percentage in calendar 2019. However, with its recent earnings release, Micron stated that customer inventories have started to decline in the PC, graphics, and cloud markets, while inventories are high in the enterprise server market. It has revised its estimate for DRAM industry demand growth to a mid-teen percentage in calendar 2019.
Micron admitted that the DRAM industry is oversupplied, with memory chipmakers holding large DRAM inventories. The company expects DRAM industry supply to grow by a mid-to-high-teen percentage in calendar 2019, and for DRAM prices to continue to fall throughout the year as supply continues to exceed demand and producers’ inventories stay high.
Whereas Micron and other DRAM chipmakers are reducing their capacity to balance supply and demand, demand uncertainty brought by US-China trade tensions has slowed the balancing process. For instance, DRAMeXchange expected DRAM prices to fall 10% and 2.5% in the last two quarters of 2019, but after the US trade ban on Huawei, it revised the estimate to 12.5% and 10%, respectively.
Micron’s NAND business
Micron is the world’s third-largest NAND supplier after Samsung and Toshiba and earns 30% of its revenue from NAND. In fiscal 2019’s third quarter, Micron’s NAND revenue fell 18.3% sequentially to $1.48 billion as its ASPs fell 15% and volumes fell 5%. Micron’s NAND ASP decline was lower than the industry’s NAND price decline of 20%, according to DRAMeXchange. It earned over 66% of its NAND revenue from high-value NAND solutions.
Micron has been increasing 96-layer 3D NAND’s contribution to its mix, which is bringing cost benefits. It is also developing its first-generation replacement gate 128-layer 3D NAND to be used in a smaller set of NAND products. This launch will be followed by a full-fledged roll-out across its entire NAND portfolio from the second generation onwards.
Micron is also shifting to NVMe (non-volatile memory) SSDs (solid-state drives). It launched its 9300 NVMe SSDs for cloud and enterprise markets in the third quarter of fiscal 2019, more than doubling bit shipments of its new NVMe client SSDs to large PC original equipment manufacturers.
NAND industry outlook
NAND is used as storage in devices. Its demand is sensitive to prices. NAND prices have been falling since last year as most chipmakers transitioned from 2D planar NAND to 3D NAND and created an oversupply situation. According to DRAMeXchange, all NAND chipmakers’ NAND ASPs fell 20%–30% in the first quarter, and they are expected to continue falling in the second half of the year.
NAND demand is increasing as prices fall. With its latest earnings release, Micron forecast calendar 2019 NAND industry bit demand growth in the mid-30% range. NAND chipmakers have been addressing oversupply by reducing their capacity.
In Micron’s fiscal 2019 third-quarter earnings call, CEO Sanjay Mehrotra stated that NAND chipmakers’ previous capital spending cuts would reduce the NAND industry’s supply in the second half of calendar 2019. However, further capital cuts are needed to bring the NAND industry supply in line with demand. Micron now plans to reduce its NAND capacity by 10% in calendar 2019, doubling its previously announced capacity reduction of 5%. He stated that Micron plans to significantly cut its capital spending in fiscal 2020.