The Bear Case For Micron. This Time Is Not Different

Micron (NASDAQ:MU) has been a great long with the stock up 59% over the past year and up 180% over the past 3 years. The company has benefitted from a cyclical recovery in memory pricing and demand. In addition, secular tailwinds are helping like the proliferation of mobile devices, growth in data centers, and consolidation in the semiconductor industry. Bulls of the stock point to the current strong DRAM pricing environment.

Source: Koyfin

The bears rightly focus on the future and especially on the dynamics in the supply chain. Sure, pricing is healthy now, but historically a strong pricing environment like today brought on new capacity. Several major brokers have come out with notes cautioning about the pricing environment over the near next 6-12 months. For example, GS recently put out a note highlighting potential weakness in the NAND market (about 1/3 of revenues):

We believe NAND flash remains oversupplied, and we believe that the outlook for NAND pricing is incrementally weaker for 3Q18 (some industry contacts we spoke to suggested that NAND pricing could be down in the mid to high teens range qoq, compared to the prior view that we had heard in June on our trip to Asia of down 10-15% qoq).

In the same note, it highlights the potential for the pricing environment to soften for DRAM servers (DRAM is 2/3 of revenue and servers are 40% of DRAM):

However, we heard at the event that US hyperscale customers will likely moderate server DRAM procurement in 1H19. This is because they now have more inventory on hand, and as current projects/contracts wrap up, there is more of a focus on price instead of just getting supply at any cost. We view this datapoint as a potential negative inflection, as server DRAM has been the clear bright spot for the market.

The GS note is not overly bearish on MU because the weak data points are just starting to creep into the market. However, the cracks in the bullish pricing story are starting to appear, and it’s evident the strong pricing environment is causing the market to adjust.

Historically this has always been the case. High EBITDA margins happen in an environment with strong demand and low inventory in the supply chain. Historically the stock peaked around the time EBITDA margins are near a peak. This is because the semiconductor business is cyclical and EBITDA margins don’t remain high for a prolonged period of time as supply and demand adjusts.

Source: Koyfin

The bulls further hang their hat on the potential of other growth markets such as automotive and internet of things. The reality is that these markets will make up a small portion (<10%) of overall revenue over the next year. Perhaps 3-5 years out these markets will be bigger.

Bulls argue that valuation is attractive, which is true at face value on an absolute basis. On a forward EV/EBITDA basis, the stock trades at 2.6x. Historically the stock trades between 2x and 8x forward EV/EBITDA. However, this low valuation suggests the market is anticipating that the current level of EBITDA is unsustainable and will decline. In cyclical sectors such as semiconductors, refiners or commodity producers, the time to be long is when earnings are low or negative. The time to sell is when earnings are high and face-value valuations are low.

Source: Koyfin

Hedge funds have been net sellers of MU collectively. According to the aggregated 13-F filings, hedge funds have reduced their position in MU from 8% to 7% over the past 2 quarters. Koyfin will calculate the recently released 13-F filings over the next week to see if hedge funds have continued to reduce positions.

Source: Koyfin

Short interest as a % of shares outstanding is low relative to history. Looking back over the past 30 years, short interest was near the low when the stock peaked.

Source: Koyfin

The MU bulls suggest this time is different. Perhaps it is. However it’s more likely that the cyclical forces in the memory industry will cause pricing to get weaker over the next year and MU fundamentals will follow.

Technically the stock broke its uptrend on August 6. The stock will likely test a big support level at $36. For investors with an investment horizon of several years, the next 6 months will likely present an attractive opportunity to buy the stock at a lower level than today.

Source: Koyfin

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.