MU - Micron: A Strong Buy Signal

2023-03-29 07:23:50 ET

Summary

• Memory chip down cycle has shown signs of a bottom.
• Micron is expecting sequential growth to start back up as the industry is expected to benefit from secular trends and change in a cyclical cycle.
• The US government's harsh stance against China is expected to benefit Micron as it will be damaging for SK Hynix and Samsung, Micron's competitors.

Introduction

It is a well-known fact that the semiconductor industry, especially the memory chip industry, has been in a cyclical downturn for the past year. Although the boom and bust cycle in the industry is fairly normal, the magnitude of the current one worried some investors. Fears of an extended period of oversupply and bloated inventory with no clear signs of a turnaround has prompted numerous sell-side opinions or hold rating on Micron ( MU ). In my previous article, I pointed out the bloated inventory, uncertainty in the exact timing of recovery, and Samsung's ( OTCPK:SSNLF ) intent to continue without cutting CAPEX could potentially lengthen the down cycle. As such, I had a hold rating on Micron. However, today, I believe Micron is a buy. The company, in its earnings report , signaled a trough will be in history in the coming months as Micron forecasted a rosy outlook going toward the end of 2023. Further, this clear estimate is also in-line with external analysts' forecasts gaining additional credibility. Finally, the US government is not only providing aid with CHIPS Act, but the government has also damaged Micron's closest competitors Samsung and SK Hynix providing significant benefits for Micron. Therefore, considering that the industry is showing clear signs of a turnaround in the semiconductor boom and bust cycle with US government support, I believe Micron is a buy.

Micron Earnings Report - Rosy Outlook

In the most recent earnings call , Micron provided investors with a rosy outlook. The company's management team said that the company "now believe[s] that customer inventories have reduced in several end markets" leading to "gradually improving supply-demand balance in the months ahead." Further, to provide additional details surrounding the current state of the memory chip market and cycle, the company said that the "balance sheet DIO has peaked in fiscal Q2." Noting that DIO stands for days inventory outstanding and that Micron's fiscal Q2 has already ended, I believe it is reasonable to argue that the trough of the boom and bust cycle is already history since Micron is "close to [the] transition to sequential revenue growth" once again as the company even showed signs of long-term potential by saying that "the memory and storage TAM will grow to a new record in calendar 2025" and "outpace the growth of the semiconductor industry thereafter" due to the "early stage of the...deployment of [the] AI technologies" and the huge potential of "their commercial use cases."

Clearly, Micron sees a rosy future outlook, but looking at the previous earnings call, one can get a better understanding of the current outlook's significance. In the 2023Q1 earnings call, the management team said that "the near-term market environment remains challenging and negatively impacts [the] profitability outlook." As such, the company was expecting to "continue to aggressively manage costs." Therefore, considering the swift change in the future outlook in just a single quarter, I strongly believe that going forward, Micron will start to see demand and inventory pressure relief creating a positive tailwind. It is likely that the memory chip downturn is ending.

It's Not Just Micron

Micron is not alone in projecting a rosy outlook. A positive semiconductor industry estimate from JPMorgan ( JPM ) strengthens Micron's views of the industry. JPMorgan, in its report , said that "we think the worst is over for" the semiconductor industry due to the "growing power and scale of the technology and other secular (structural) forces" as well as the "cyclical factors, such as the business cycle and market pricing."

With both Micron and JPMorgan pointing out secular forces, such as AI, and improving cyclical factors of the industry as a sign of a semiconductor strength, I believe it is reasonable for me to argue that Micron will likely be propelled by a strong tailwind going forward.

US Government has Micron's Back

The rosy industry outlook is not the only potential opportunity for Micron. As the US government's stance against China becomes increasingly harsh, Micron is expected to be one of the biggest beneficiaries. As CHIPS Act was passed last year, I will not go into the details, but Micron is expected to see more than direct benefits such as the CHIPS Act from the US government.

In 2023, the US Commerce Department, through an additional update in the CHIPS Act , effectively limited the ability of semiconductor manufacturers to advance their factories in China, which includes Samsung and SK Hynix. These companies will not be able "to engage in any significant transaction involving the material expansion of semiconductor manufacturing capacity in any foreign country of the concern." Obviously, the foreign country of concern is China, and Samsung and SK Hynix will need to abide by this rule as they will be receiving benefits from the CHIPS Act creating a significant benefit for Micron. Both companies' inability to upgrade fast-changing semiconductor factories or difficulty maintaining the current factories due to the Bureau of Industry and Security's export control on advanced semiconductor manufacturing items, it is clear that Samsung and SK Hynix are seeing future turbulence. Even more, Samsung's 40% of NAND Flash production comes from China while SK Hynix's 40-50% of DRAM and NAND Flash production comes from China. Thus, considering that the memory chip industry is dominated by just Samsung, SK Hynix, and Micron, a significant blow to Micron's competitors will likely benefit Micron.

(I dove deeper into the politics surrounding the memory chip industry and Samsung in my previous article, so please refer to this article if you are looking for more details.)

Risk to Thesis

The memory chip industry is sensitive to macroeconomic conditions. As such, any future deterioration in the currently fragile global economic condition may push the industry recovery further back than expected. Thus, investors should be aware of potential bank failures, inflationary pressure, further rate hikes, slowing consumer spending, and more factors that may degrade economic growth.

Summary

After a harsh winter in the memory chip industry due to its cyclicality, Micron, for the first time, has projected rosy future outlooks hinting that the trough is already history. Further, as outside analysts from JPMorgan are providing similar views, I believe it is reasonable to argue for a memory chip industry recovery happening in the coming quarters. Finally, with the US government's action damaging Micron's competitors, SK Hynix and Samsung, in an oligopoly market, Micron is expected to see a rosy 2023 going forward. Therefore, I strongly believe that Micron is a buy.

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