Summary
Micron is a cyclical semiconductor company that is currently in a downturn.
If this pattern repeats the first two cycles, the stock's decline will increase by 20-30%, and after several months of sideways trading, the stock should bottom out in the second half of 2019.
EPS estimate revisions are declining sharply over the past one to three months. Upward earnings per share revisions continue to confirm that the current downturn is over.
In our report published in August, we outlined the reasons for the share price decline. Micron shares have fallen nearly 40% since then. The gist of the report is that EBITDA margins have peaked and the stock is entering a downturn.
Micron Technology is a semiconductor company specializing in memory chips. Its products are generally commoditized, especially in the field of DRAM. Two-thirds of the company's revenue comes from DRAM. Cyclical companies like MU that sell bulk commodities tend to behave similarly based on the laws of supply and demand. At the top of this cycle, things seem to be going forever. Margins are high, revenue is growing, and companies are ramping up production to meet demand. The opposite happens on the way down. Revenues are falling, unsold inventory is piling up, and production cuts cannot be made fast enough. The chart below shows the recent downturn in shades of gray.
The semiconductor industry is in a downturn due to the global economic slowdown and increased supply. The key question to answer is: When will the bottom hit? We introduce a framework that analyzes the previous two downturns, 2010-2012 and 2014-2016, to put the current downturn in perspective and quantify when Micron stock prices will hit Bottomed out. Cycles prior to 2010 may not apply to the current downturn, as the industry has consolidated significantly over the past decade. Using this framework, MU is likely to bottom in February 2019, with 20-30% downside left.
Duration
Based on peak-to-trough EBITDA margins, the downturn in the first two cycles lasted 7 and 9 quarters respectively. In the current cycle, margins peaked in the August 2018 quarter. Even if the current cycle is shorter than previous cycles, 4-6 quarters may be a reasonable expectation of how long it will take for EBITDA margins to bottom out.
While the stock may bottom before fundamentals do, don't expect a v-type recovery. MU stock typically trades sideways near cycle bottoms.
Fundamentals
Without the help of a "crystal ball," it's difficult to determine where EBITDA margins will fall. Before the first two cycles, EBITDA margins will fall to single digits or negative territory. Since then, the memory industry has consolidated into 3 large companies: MU, Samsung (OTC:SSNLF), and SK Hynix (OTC:HXSCF).
It is reasonable to assume that EBITDA margins will bottom out higher than in previous cycles due to greater consolidation in the industry. The current EBITDA margin of 62.5% is still close to peak levels. The lowest profit margins in the first two cycles were 16% in 2012 and 22% in 2016. Given that trough levels have been rising over the past two cycles, a reasonable forecast range for trough margins this cycle is between 30% and 40%.
Earnings Estimate Revisions
The most important fundamental metric to track is analyst earnings per share estimates. Historically, EPS revisions coincide with stock price declines at roughly the same time.
Micron investors will need to track earnings per share revisions closely to determine when analysts start to upgrade estimates. The current correction trend is downward and very obvious. Forecasts for fiscal 2019 have fallen 21.5% over the past month.
Valuation: not cheap enough
Using the price-to-earnings ratio as a valuation indicator to analyze net asset value is not effective. Like other highly cyclical stocks, P/E ratios look high during downturns because earnings are suppressed. A casual look at this stock would lead you to think that it is expensive, but in fact, it is not expensive because of its poor earnings. On the other hand, at the top of a cycle (like last summer), the P/E ratio is low and optically the stock looks cheap.However, this is because earnings are temporarily overstated.
A more efficient method is the price/dispute book (P/TB). It measures a stock's price against its accounting value based on previous earnings and investments. The current P/TB is 1.1x, compared with the bottoms of 0.7x and 0.8x in 2012 and 2016, respectively. Although Motorola University is approaching "cheap" status, its previous lower P/E ratio suggests its valuation is 30-40% below trough.
realize trade
MU is experiencing an unprecedented downturn and the stock is likely to see more losses in the medium term. For traders/investors with a 6-9 month investment horizon, MU may fall another 20-30%, making this an attractive short-term opportunity.
For long-only and value investors, MU will provide a buying opportunity later this year. Use history as a guide and wait until P/E ratios are "very cheap" before making a decision. Additionally, be patient until earnings revisions start to trend upward before buying a stock. Once analysts start raising their EPS estimates, it's a good sign that the cycle has entered an upward phase.
Author of this article: Rob Koyfman, things about Wall Street (public account: meigushe) www.meigushe.com
