Micron Climbs 4.6% over Anticipation of 2020 Recovery

Yesterday, Micron Technology (MU) stock rose 4.6% after hours as its Q1 of fiscal 2020 earnings beat estimates. The stock rose despite weak guidance as its CEO announced the end of the cyclical memory downturn in the second quarter of fiscal 2020. This announcement sent the stocks of peer Western Digital (WDC) up 3% and equipment suppliers Applied Materials (AMAT) and Lam Research (LRCX) up 1.2% and 1.1%, respectively.

Micron is a pure-play memory chipmaker and is heavily influenced by memory prices. Memory is a cyclical market where prices are determined by supply and demand. The memory market is consolidated with a few companies commanding more than 95% of the memory and storage market.

Among the key players are Samsung, SK Hynix, Micron, Toshiba, and Western Digital. Micron is the only company that has an extensive portfolio of DRAM (dynamic random access memory), NAND (negative AND), and 3D XPoint products. So, its earnings give a clear picture of how the memory market is performing.

Five key announcements in Micron’s Q1 of fiscal 2020 earnings

In the first quarter of fiscal 2020, Micron’s revenue rose 6% sequentially to $5.14 billion, beating the analyst estimate of $4.99 billion. This growth was largely driven by strong demand in the data center and mobile markets. However, things were weak on a YoY (year-over-year) basis, with revenue down 35%. Micron guided revenue of $4.65 billion at the midpoint for the second quarter of fiscal 2020, which fell short of analysts’ estimate of $4.75 billion.

Investors should look beyond these earnings figures at some key announcements Micron CEO Sanjay Mehrotra made at the latest earnings call. Let’s look at these announcements and deduce what they mean to investors with exposure in memory stocks.

Micron’s latest acquisitions

In the first quarter of fiscal 2020, Micron made two acquisitions. It acquired Intel’s (INTC) stake in IMFT (Intel Micron Flash Technologies) for $1.5 billion in cash. With this, Micron aims to get full control over the 3D XPoint plant in Utah and accelerate its R&D (research and development). The impact of this was visible as Micron also launched its first 3D XPoint product, X100, after announcing this technology in June 2015. Although X100 should take time to materially impact Micron’s revenue, it is a start.

The next acquisition in Micron’s basket was of startup FWDNXT, a deep learning platform that, when combined with Micron’s memory, can support inference in edge devices. This shows Micron’s interest in tapping the AI ecosystem. These acquisitions reduced its liquidity by $2 billion to $11 billion. These acquisitions could help Micron expand its mix of high-end memory and storage solutions that generate higher margins.

Micron secures licenses to trade with Huawei

Beyond acquisitions, Mehrotra also discussed some of the most pressing issues plaguing the semiconductor industry. One of these was the US ban on Huawei implemented in May. The ban restricted Micron from supplying certain products to Huawei unless it obtains a trade license from the US authorities. In its Q3 of fiscal 2019 earnings call, CFO David Zinsner stated that the Huawei ban cost the company $200 million in revenue and $40 million in inventory writedown.

In the company’s Q1 of fiscal 2020 earnings call, Mehrotra stated that Micron has secured the requested licenses to qualify and supply certain products for Huawei’s mobile and server businesses. He added that this qualification process would take some time. As a result, Huawei’s revenue would not be reflected in Micron’s next few quarterly earnings. Moreover, he stated that Micron is still not able to supply some products to Huawei’s other business segments.

What is interesting is this whole trade war has made Huawei skeptical of US suppliers. The Chinese giant sought alternative suppliers to reduce its dependence on the US. It remains to be seen how many orders Micron gets from Huawei. However, Mehrotra emphasized that the products licensed represent a very small portion of Micron’s revenue. So, Huawei would not have a material impact on the memory chipmaker’s revenue.

Micron Climbs 4.6% over Anticipation of 2020 Recovery

Inventory build from China impacts Micron’s industry outlook

Amid the trade war uncertainty, some semiconductor companies saw Chinese companies stock up inventory ahead of the December 15 tariffs. Intel realized $200 million worth of fourth-quarter data center sales in the third quarter because of demand pull from China. Even Mehrota witnessed a similar trend.

Mehrotra explained that Micron increased its DRAM industry demand growth outlook for 2019 to about 20% from the mid-teens as stronger-than-expected demand pull from China created “pockets of shortages” for the chipmaker. However, Micron lowered its DRAM demand growth outlook for next year to the mid-teens from the high teens to 20% as China moves to absorb its excess inventory. For the NAND industry, Micron maintained its demand growth outlook for 2020 at the high 20% to low 30% range.

In both DRAM and NAND, Micron expects demand to overtake supply, thereby improving prices. This improvement comes as memory chipmakers control supply by reducing capital expenditures. Looking at the improvement in the supply-demand balance, Mehrotra noted that Micron’s earnings could hit bottom in the second quarter of fiscal 2020 and start growing from that point.

If we look at Micron’s last downturn in 2016, it resulted in six consecutive quarters of YoY revenue declines. That downturn ended in Q4 of fiscal 2016 when Micron’s DRAM ASP declines slowed from the low teens to mid-single-digit percentage range.

Now, history is repeating. Micron expects to report its fifth consecutive quarter of YoY decline in Q2 of fiscal 2020. Moreover, its DRAM ASP declines slowed from 20% to 9% in the first quarter of fiscal 2020. Taking a cautious approach, we believe that the downtrend could end in the first half of 2020.

Sanjay Mehrotra excited about game consoles and 5G opportunities in 2020

The above outlook assumes the macro and trade environment remains stable. This assumption seems unlikely, as President Donald Trump was impeached just a few hours before Micron announced its earnings. It remains to be seen how his impeachment impacts the China trade war. The macroeconomic environment could continue to haunt Micron, but the changing technology landscape makes the chipmaker excited about 2020.

Discussing end-market opportunities, Mehrotra stated that Micron would benefit from the growing adoption of 5G smartphones, which have significantly higher memory and storage content. He stated that the early 5G smartphones launched so far have an average 8GB (gigabyte) DRAM and 200GB NAND.

As 5G technology enters the midrange phones, the minimum DRAM content could reach 6GB. Mehrotra stated that Micron had started volume production of its lowest-power and highest-bandwidth LP5 DRAM to tap the 5G smartphone opportunity.

The next big opportunity Mehrotra is eyeing is Microsoft and Sony’s next-generation game consoles, which are scheduled to launch in 2020. This next-gen shift comes after seven years, and the consoles would feature ray tracing technology. The first few years should see strong growth.

Micron Climbs 4.6% over Anticipation of 2020 Recovery

How to invest in memory stocks

The best way to invest in memory is through Micron and Western Digital, as their core business is memory and storage. These stocks report exponential growth during a memory uptrend and significant falls during a downtrend. The key to investing in these stocks is to buy when the industry is at the end of a downtrend and sell when it nears a downtrend.

The question is, how do we know when an uptrend starts? The answer is memory prices. Both Micron and Western Digital report the change in their ASP (average selling price). If the ASP trend is reversing from negative to positive, it indicates the end of the downtrend.

In the last uptrend from June 2016 to June 2018, Micron stock rose as much as 355% to over $60. In the following downturn, the stock price almost halved in just six months. Western Digital stock rose 169% to over $105 in the 22-month uptrend from May 2016 to March 2018.

So, it doesn’t come as a surprise that Mehrotra’s comment on the memory cycle is creating so much noise. In July, Micron stock soared over the anticipation of memory uptrend, but the trade war escalation delayed the trend. Now, the supply has declined considerably and could continue to fall in 2020.

The 5G and game console opportunities will drive memory demand. The memory industry could return to the uptrend in the second half of 2020. Looking at Micron and Western Digital’s triple-digit increases in stock price during an uptrend, we believe the two stocks are a good buy although they have grown more than 50% from their lows.