Summary
Like it or not, Micron's stock price has a higher correlation to DRAM/NAND prices than underlying financial prices.
Micron's stock price tends to keep DRAM prices stagnant at the top of the cycle for about 6-8 months due to the offsetting benefits of bit growth.
As stock prices "look forward" to the upcoming DRAM bottom, stock prices tend to cause DRAM prices to be close to the cycle bottom for about 2-3 months.
Micron's lagging (leading) at the top (bottom) of the commodity price cycle provides a strong rationale for investing in commodity stocks with direct exposure to underlying commodities.
Taking advantage of the historical lead-lag relationship, Micron stock could see a near-term bottom near $25 in the first quarter of 2019.
With a bearish view on Micron Technology (NASDAQ:MU) stock, valuing the stock based on its financials seems pointless. It's hard to imagine Micron stock trading at a 50% discount to the fair value estimated by most street analysts. So, it might be time to recognize that there are several non-company-specific reasons driving Micron's share price. It should be noted that CEO Sanjay Mehrotra's "tariffs will have a 50-100 basis point impact on gross margin" and that "oversupply may be resolved in 2-3 quarters" or the company's $10 billion stock return Purchase plans may not be sufficient to affect stock prices in a meaningful or permanent manner. But these factors will continue to impact 2019.
As a commodity stock, Micron's stock price is in line with the DRAM/NAND 4-year price cycle, more prominently compared to forward revenue and EPS. The prevailing short thesis is that Micron is just another commodity stock subject to cyclical declines, which may be why MU fell from $61 in June to its current low of $30. In this article, I estimate that Micron's price will likely be viewed from the perspective of being primarily affected by DRAM/NAND price trends, at least in the short term.
Micron Stock Cycle and DRAM/NAND Cycle
Due to cyclical characteristics, DRAM and NAND prices are always determined by the demand and supply of memory chips, so demand has long been estimated to weaken after 2019. There are further indications that production efficiency will increase in the near future, including South Korea's exports. The net effect is that both DRAM and NAND prices are poised to begin their two-year downward cycles. In anticipation of weaker commodity prices, Samsung (OTC: SSNLF) and SK Hynix (OTC:HXSCF) recently announced that they will reduce supply. However, due to the near-oligopolistic memory industry, there is no guarantee that the few companies that reduce supply will automatically increase prices.
Micron's stock price is well above DRAM prices
Since Micron's revenue is 70% exposed to DRAM and 26% exposed to NAND chips, its stock price follows a similar DRAM/NAND cycle, which is a four-year cycle (Figure 1A and Figure 1B). However, in the way that stock and commodity prices are related, the good news is that Micron's stock price is also more predictable, as stock prices tend to rise after commodity prices rise. In Figures 1A and 1B, the top of the MU (H1 and H2 in black) tends to appear some time after the top of the DRAM (H1 and H2 in red). The lag time is about 6-9 months. Price lag is considered an attractive investment property because MU prices will still rise long after DRAM prices peak. Micron stock has longer upside potential. It also shows that stock prices can be affected by factors other than commodity prices.
The fact that Micron stock lagged DRAM prices at the top of the cycle suggests that investing in commodity stocks can provide a better risk-reward ratio than investing directly in the underlying commodity. When DRAM prices fall due to excess supply, the resulting lower average selling price (ASP) also stimulates more demand for the commodity as the demand curve slopes downward. Micron's bit growth (volume) will increase to offset some of the negative impact of lower ASPs on revenue. In fact, even as DRAM prices or ASPs have declined, Micron's revenue and stock price have been rising, while bit growth has continued to grow (Figure 2A and Figure 2B).Until recently, in March 2018, neither ASP nor bit growth had declined. It was only after investors factored in that both ASP and bit growth would slow that MU's stock price began to fall back in March. In other words, bit growth helps delay the negative impact of weak commodity prices on revenue.
Micron is No. 1 in price
At this critical moment, it should be reassuring to see Micron's stock price slide (L in black) long before DRAM prices hit bottom (L in red). There are signs that Micron shares tend to bottom out around 2-3 months, with shorter lead times than the lag time at the top. Since typical DRAM cycles are three to four years long, down cycles often correspond to recessionary economic cycles, which reduce demand. As DRAM approaches the end of its downtrend, bit growth has slowed and is even trending downward. The source of lead time near the lows could be the result of stock prices being forward-looking. Unlike the near-top, investors are more focused on the timing of when DRAM prices bottom out, and less on when bit growth will reverse. It should be clear that volume adjustments to bit growth tend to lag price changes. In both cases, Micron's stock price responded more to DRAM prices than to price growth. This is an important historical pattern if it can be explained by economic intuition. Since Micron's stock price fell by more than x% since its last high of x, investors are very worried looking for signs of a bottom in the stock price. Therefore, based on the historical lead-lag relationship between MU's stock price and DRAM's price, if the next low for DRAM's price can be determined, I will be able to estimate the next low for Micron's stock price.
Micron's stock price has begun to factor in weak DRAM/NAND demand in the first half of 2019 as the market worries about an upcoming recession. Analysts predict that NAND prices will fall by 10% in the first half of 2019, and DRAM prices will fall even more. As a result, I am able to estimate that the price of MU may hit a near-term "bottom" around $25 (Figure 3), assuming the same historical cycle (Figure 3 dashed line).
Tips
Micron’s near-term bottom forecast of around $25 should be met with multiple warnings. At this point, my thesis is that fundamental stock valuation becomes least relevant, as MU's stock trades close to 50% relative to long-term fundamental fair value. While the recent trade war may intensify, the main source of bearish sentiment is Micron's commoditization, which was predicted and debated long before the trade war broke out. Since political outcomes and the timing of trade war resolution are nearly impossible to predict, estimating the long-term impact of the DRAM/NAND price cycle on the Micron stock price cycle remains informative. Most importantly, barring any major surprises in the 90 days of trade talks
