For now, this market is more than willing to pay through the nose for companies seen as high-growth plays on secular tech trends. But it’s setting a much higher bar for tech firms seen as cyclical plays.
And just maybe, that’s creating some buying opportunities within the latter set of companies.
Micron Technology (MU) , which is down more than 5% since posting its May-quarter report on Wednesday afternoon, is a good case in point. The memory giant topped estimates — as expected, after it forecast in late May that sales would be at or above the high end of its prior guidance range — and issued August-quarter sales and EPS guidance that was fully above consensus. But some of Micron’s commentary about capex plans and expected cost headwinds apparently didn’t go over well.
Specifically, Micron forecast capex would equal a mid-30s percentage of revenue in the coming years (above prior guidance for a low-30s percentage), as it buys EUV lithography tools from ASML Holding (ASML) for use in DRAM manufacturing processes to be deployed in 2024 and beyond. And it cautioned that it will see manufacturing cost headwinds in the coming quarters related to the start of production for its 1-alpha DRAM and 176-layer 3D NAND manufacturing processes, as well as from product mix changes and COVID mitigation costs.
Neither of these things should have a massive impact on Micron’s earnings over the next few years. Capex is only slightly increasing as a percentage of revenue, and it might come back down once the EUV transition is finished. And the cost pressures largely appear to be short-term in nature.
On the flip side, Micron shared quite a few positives via its report, earnings call and earnings slides. Among them:
- Micron slightly raised its full-year DRAM and NAND flash demand growth outlooks, while forecasting DRAM and NAND would have favorable supply/demand balances into 2022.
- With memory spot and contract prices still trending upward, Micron disclosed its DRAM average selling price (ASP) rose by about 20% sequentially in the May quarter, and that its NAND ASP rose by a high-single-digit percentage.
- The company was generally positive about end-market demand trends, highlighting strength within segments such as server DRAM (boosted by strong cloud capex), automotive products, graphics memory and PC DRAM and SSDs.
- In spite of its manufacturing cost comments and guidance for DRAM bit shipments to be roughly flat sequentially due to the 1-alpha transition, Micron guided for August quarter revenue and EPS to be comfortably above May quarter levels, thanks to continued ASP growth.
Micron’s 2021 DRAM and NAND supply/demand outlook. Source: Micron.
All things considered, the odds look good that the current memory up-cycle doesn’t end before at least mid-2022, with a fair amount of additional ASP growth happening between now and then. Particularly since there’s a lot of unmet demand right now in several large memory end-markets (notebooks, gaming hardware, cars, etc.) due to shortages for various non-memory chips and components.
And with Micron’s earnings inflecting higher and the company having committed to returning at least half its free cash flow via stock buybacks, buybacks are likely to rise sharply in the coming quarters relative to a May-quarter total of $150 million.
But since mid-May, equity markets have been in a pretty unforgiving mood towards most commodity and cyclical plays, whether inside or outside of tech, as money keeps flowing into companies seen as secular growth plays, regardless of their multiples. As a result, Micron, whose stock had already been treading water for several months, fell post-earnings thanks to its capex and manufacturing cost comments, and is now trading for less than 7 times a fiscal 2022 (ends in Aug. 2022) EPS consensus of $11.56 that looks a little conservative given Micron’s buyback plans and how memory demand and ASPs look set to trend into early 2022.
Admittedly, valuing a company prone to seeing massive cyclical earnings swings isn’t as easy as slapping a P/E on its peak-cycle EPS. If one values Micron based on the $2.31 in EPS it produced between its Aug. 2019 and May 2020 quarters during the last memory down-cycle, then its stock doesn’t look so cheap.
One back-of-envelope approach to valuing such a company that I think makes some sense is to take the company’s cyclical-bottom and cyclical-peak four-quarter EPS figures, calculate their midpoint, and assign a P/E to that number.
In Micron’s case, we’d have a midpoint EPS figure of $7.41 if its annual EPS peaks at $12.50 during the current cycle. If it peaks at $14.00, the midpoint would be at $8.16. Assigning a P/E of 15 to those numbers would respectively yield valuations of $111/share and $122/share — soundly above Friday’s closing price of $80.33.
In that context, Micron’s stock still looks inexpensive, particularly given how (after adjusting for cyclicality) Micron’s earnings are poised to benefit long-term from buybacks, steady memory consumption growth and (thanks to industry consolidation) controlled DRAM supply growth.
This isn’t a stock that’s likely to generate truly epic returns from current levels over the next six to 12 months. But I think it could generate good ones. And against a backdrop of growing inflation risks, its risk/reward over that timeframe looks much better than the ones that exist for many of the secular growth plays that now sport nosebleed multiples.
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