Micron Technology (MU) and other semiconductor stocks started rallying in September when China confirmed that it will no longer retaliate. This was a positive step in the United States-China trade negotiation process. MU stock is sensitive to the trade war because of its high exposure to China. Micron and the VanEck Vectors Semiconductor ETF (SMH) rose 8% and 9%, respectively, from September 3 to 20.
Micron and its exposure to China
MU earns 50% of its revenue from China, of which about 17% comes from Huawei. In May, the United States imposed a trade ban on Huawei, which it later eased. Moreover, most of Micron’s facilities are located outside the United States—in Taiwan, Singapore, Japan, and China.
The big question is whether Micron’s rally is the beginning of the stock’s recovery, or whether it’s just the silence before the storm? The answer is subject to the outcome of the China trade war.
If the trade war eases, this rally could be the start of memory market upturn. If the trade war escalates further, this rally is a false alarm. In this article, we’ll look at both scenarios and the probability of each of these scenarios materializing.
Micron’s stock price is directly proportional to DRAM (dynamic random access memory) and NAND (negative AND) prices, which are governed by supply and demand forces. When the United States-China trade war started in 2018, it impacted the technology sector—semiconductors in particular.
Since May, the United States has imposed a 25% tariff on $250 billion in Chinese imports and a 15% tariff on another $125 billion of Chinese imports. This brought some components of Micron and some products that use Micron chips under the tariffs.
Threefold impact of China trade war on Micron
Micron listed the trade war as a business risk in its SEC filings and listed the threefold risk that the trade war brought to its business. The first element of the trade war risk was the direct impact of tariffs on its goods that it imported from or exported to China.
Tariffs made its goods expensive, putting it at a cost disadvantage over its South Korean rivals, Samsung and SK Hynix. However, Micron shifted its production from China to other countries to save on tariffs. So, it incurred the cost of shifting operations.
The bigger blow came from the second element of the trade war risk, which is the indirect impact of tariffs on consumer demand. The trade war brought Micron’s customers’ products into the tariff band.
The uncertainty around the trade war reduced demand for products like servers, PCs, smartphones, and SSDs (solid-state drives) that use Micron’s chips. Businesses started manufacturing cautiously and stopped buying memory chips, which impacted Micron’s orders. Reduced demand for end products pulled down Micron’s ASP (average selling price) and its sales.
The third element of the trade war risk comes from trade barriers such as trade bans or restrictions of the goods that can be supplied. The US ban on Huawei in May saw Micron write down $40 million of inventory, which it had made specifically for Huawei in the third quarter of fiscal 2019.
China threatened to restrict the trade of rare earth minerals, which are necessary for making memory chips. Micron’s SEC filings state that if this threat materializes, it could impact the company’s ability to “produce products, increase our selling and/or manufacturing costs.”
Micron benefits from the Japan-Korea trade war
South Korean rivals are exposed to this risk, as Japan has restricted the export of three chemicals used in the manufacturing of memory chips to Korea. Samsung and SK Hynix accounted for over 60% of global memory supply last year.
Longbow analyst Nikolay Todorov stated that the Japan-Korea issue tightened the memory supply. So, excess inventory of memory chipmakers is shrinking faster than anticipated.
When could the China trade war ease?
If the China trade war eases, Micron would be free from the threefold risk arising from demand and trade uncertainty. This brings us to the question—will the trade war escalate or ease? When could a trade deal be reached?
The trade war has reached a level where all imports and exports between the United States and China face a tariff. This situation has started to slow the economies of the two countries and the global economy at large. Both countries’ presidents are facing international pressure from a coalition of Australia, Canada, Singapore, and Indonesia.
With the US elections due next year, President Trump might not want to put the economy into recession. Plus, China is showing a willingness to negotiate. While we see signs of easing in the trade war, there is still uncertainty that the war might escalate. It is this uncertainty that is keeping analysts and investors on their toes.
According to a September 10 article in The Street, KeyBanc analyst Weston Twigg sees “early signs” of a memory chip recovery. DRAM and NAND inventories are falling, and NAND prices are rising steadily. DRAM price declines are slowing and should stabilize by the end of the year.
The supply is well-managed with few players and high entry barriers. What needs to improve is demand. Twigg wrote, “Barring a recession, we expect memory trends to improve through 2020” as long-term demand drivers kick in.
Another argument we can note is the tenure of a cyclical downturn. Historical data has shown that an industry downturn lasts for about 12 to 16 months. Micron is currently in its tenth month of the current downturn, and we can expect the downturn to end in early 2020.
Micron stock rallied in June and July as trade tensions eased. The stock then fell in August as the trade war intensified with new tariffs. It rallied once again in September as new signs of easing appeared. This roller coaster ride shows that although Micron stock has growth potential, it is conditional.
Micron is not like NVIDIA or Intel, which should appreciate in the long term. It is a cyclical stock where the investor books profit in an upturn. As a result, the stock has limited upside potential. The stock is currently trading close to its 52-week high. This is a good time to hold the stock for those who already have a position.
However, the stock could fall significantly if the China trade war accelerates or if the fears of recession materialize. If any of these events happen, it could open a buying opportunity for investors. As the rule goes, buy when memory prices are down and sell when memory prices are up. This is easier said than done.