Technology growth

Micron Technology: growth engines are already integrated

Mmicron technology (MU) still has great potential in the memory market, primarily due to the EBU market, which grew 51% year over year. This driver is determined by the growth of the electric car market, 5G networks and the IoT market, which require advanced types of memory.

We expect the company to improve its profitability by increasing its margins. Also, a hidden opportunity for growth in profitability is low financial leverage. According to our assessment, MU is trading at a slight discount to the fair price. The margin of safety is insufficient for the purchase. We are neutral on the company.

Company profile

Micron Technology specializes in the development and sale of memory (NAND and DRAM) for a variety of markets and consumers. The company consists of the following units:

  • CNBU – Compute and Networking Business Unit (includes consumer markets, cloud server, enterprise, graphics and networking sales);
  • MBU – Mobile Business Unit (sales memory for mobile phones);
  • SBU – Storage Business Unit (sales of SSDS for the cloud and enterprise market, customer and consumer storage);
  • EBU – Embedded Business Unit (sale of memory and data storage for automotive, industrial and consumer market).
Source: created by the author

Industry overview

According to SDKI, the semiconductor memory market is estimated at $115 billion and will grow at a CAGR of 12.6% through 2025.

Source: created by the author

MU operates in the fastest growing market segments. According to Bloomberg, automotive semiconductors will grow at a CAGR of 11.80% and the IoT market at a CAGR of 25.4%, according to research from Fortune Business Insights.

In the first quarter of fiscal 2022, Micron’s automotive and industrial segment grew 25% year-over-year. The company forecasts that revenue from this segment will grow at a CAGR of 40% over the next three years.

We expect solid growth in both markets. We expect – overall, if you look at the CAGR of DRAM content in the automotive market, it’s around 40% over the next three years

CEO Sanjay Mehrotra during the last conference call

The IoT (Internet of Things, EBU) segment, Industrial IoT, grew 80% year-over-year, also showing strong growth. Consumer IoT grew 40% year-over-year thanks to the increase in virtual reality headsets and smart home devices.

We expect IoT demand trends to accelerate further as 5G accelerates the adoption of data-intensive applications powered by intelligent edge infrastructure.

CEO Sanjay Mehrotra during the last conference call

Thus, we see great potential in the markets that form the EBU segment. Currently, demand in these markets far exceeds supply. Companies will only cover this imbalance in 3-4 years. The segment now accounts for 15% of revenue ($4.2 billion) and is the third largest. If growth matches management’s expectations (which seems realistic), segment revenues will reach $9.6 billion by 2024.

Financial performance

On average, Micron Technology’s revenue has grown 17.4% per year over the past five years. Currently, the company derives 75% of its revenue from long-term supply contracts; 4 years ago, this figure was 10%. This eliminates the likelihood of high volatility in Micron’s earnings.

Source: created by the author

Currently, the net profit margin is 21.1%, with a gross margin of 37.7% and an operating margin of 24.5%. Margin indicators have increased during the pandemic due to rising semiconductor prices.

Source: created by the author

UM’s current asset turnover is significantly lower (0.5) than its maximum value (0.7), due to lower revenues in 2019 and 2020. However, in the current market environment, asset turnover can reach 0.6, which will lead to a 2pp increase in ROA

(Source: Created by the author)

Since 2017, the assets/equity ratio has been 1.3. Low leverage is a hidden driver of profitability growth. If the company increases its financial leverage to 2, with the current net margin and asset turnover, it will increase the return on equity by 6.4 percentage points to 19.8%.

(Source: Created by the author)

Given the current market environment, we expect the company to continue to improve profitability through improved margins and asset turnover. We are already seeing that the inventory balance for the last four quarters is lower than last year. Low leverage is also a hidden profitability driver. Only by increasing leverage can MU significantly improve return on equity.

Evaluation

In our DCF model, we made several assumptions. We expect revenue growth in line with the Wall Street consensus. Margins and other relative indicators are predicted based on historical momentum and current trend. The terminal growth rate is 4%. Our assumptions are presented below:

Based on our assumptions, the expected dynamics of the key indicators are shown below:

(Source: Created by the author)

With a cost of equity equal to 10%, the weighted average cost of capital (WACC) is 9.6%.

(Source: Created by the author)

With a terminal EV/EBITDA of 6.8x, the company’s fair value is $160.1 billion or $106.47 per share. Thus, the company is trading at a 12% discount. The safety margin is insufficient.

The P/E multiple is higher than that of the competitors and is equal to 14.4. The average P/E for the semiconductor industry is 22.2. On EV/EBITDA, Micron is trading at a premium to its peers.

Micron Kioxia WD SK Hynix Intel Industry average
PER 14.4x 11.37x 12.8x 11x 12.2x 22.2x
EV/EBITDA 6.8x 9x 8.35x 6.1x 6.7x 18.5x
Source: created by the author

The Taking of Wall Street

From Wall Street analysts, Micron has a buy analyst consensus based on 18 buy, 4 hold and 1 sell ratings. At $108.18, MU’s average price target implies 12.4% upside potential.

Conclusion

Micron Technology is the memory market leader and can grow at double-digit rates in the EBU segment. MU can improve profitability by increasing all three components: net margin, asset turnover, and financial leverage. However, it looks like all of the above drivers are already included in the stock price.

According to our assessment, the company is trading at a slight discount, but the margin of safety is insufficient. In particular, our price target is in line with the Wall Street consensus. Thus, we expect a more attractive entry point.

Disclosure: At the time of publication, Vladislav Kolomeets had no position on any of the stocks mentioned in this article.

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