Unfortunately, Micron’s (MU) guidance for Q1FY19 was much weaker than what I was expecting.
There are a couple of factors affecting guidance that I believe are actually blown out of proportion. First and foremost, Micron’s tax rate is expected to increase from 2% to 12.8%. This is drastic increase that was expected due to the next tax bill. On a proportional basis, I believe the tax rate alone will decrease EPS by about $0.34.
In addition to this, tariffs and CPU shortages became a big point of contention. It is hard to estimate an exact impact of tariffs, but I estimate this will reduce EPS by about $0.12 (even more if tariffs become 25% rather than 10%). Intel has three facilities making 14nm chips, and though Intel already spent $1bn on CAPEX, adding even more production takes time. This slow-down in production is a short-term loss for Micron as PC makers aren’t buying as many memory chips because of slowed production due to scarce CPU chips. Unfortunately, the weakened demand on Intel causing shortages is expected to last about 2 quarters.
Micron expects DRAM to up about 22% YoY and NAND to be up as much as 45% YoY for the remainder of 2018. For 2019, Micron expects DRAM bits to grow another 20% YoY and for NAND to slow the growth to only 40% YoY.
Micron believes that DRAM profit GM will remain strong, if not increase, while NAND supply to moderate itself due to 96L challenges (Sanjay touched on this during the call. Approx. 37:00). Micron will also actively work to produce 3D X-Point.
SEMI’s World Fab Forecast data point to an improbable eye-watering fourth consecutive year of fab equipment spending growth to the tune of 5 percent.
When putting FAB spending on the same axis as aggregate revenue, we see that this carries an r2 value of 0.772, which is very strong.
So this shows us that an increase in FAB spending should lead to an increase in revenues, which should drive the stock prices higher even if the multiples aren’t changing.
On this note, Intel is expected to spend $5 billion in Israel this year, while Micron is opening a new facility in Singapore this year as well. Micron is also opening a new facility in Singapore. Overall FAB spending in expected to see a 5% CAGR spending starting this year.
Inkwood Researchsees the semiconductor market growing at 7.67% CAGR through 2024, ending with an $835bn market by then. In 2017, the semi market was $499bn with $364bn in sales. Discounting these numbers at the same rate (73%), this gives us $607bn.
Obviously the market is discounting that growth by a fair bit, with concerns of cyclicality and a drop off in prices. The semiconductor cycle is boom and then bust. We’ve clearly had some boom, but have we had it all?
Going into 2018, a KPMG survey found the semi cycle to be mostly expansionary still.
Concerns of seasonality/cyclicality have started to really grow. After a huge runup in SOXX (semiconductor ETF) over the past few years, it’s up 5% this year so far with long peaks and troughs, running up strong when the market is running good (December/January) and getting hit hard in overall pullbacks (February).
Memory Outlook (As per BoAML):
As I stated above, the entire semiconductor industry hasn’t reached its peak, and I don’t believe it will for at least 10 years. Recently, Merrill Lynch analyst Simon Woo visited South Korea (one of the biggest countries for memory) and had many positive things to say about the industry:
- CAPEX remains conservative for wafer fabrication equipment and incremental spending is mostly absorbed by shell fab construction.
- DRAM market is seeing low inventory levels for a few weeks. NAND inventories are behind by 4 weeks.
- ASP in 2019 should remain stable.
- NAND ASP in the rest of CY18 should be smaller than expected.
- Tariffs will have a minimal impact.
- DRAM demand is solid (30-40% bit growth).
- Their guidance is weaker than I would’ve liked regardless of the reason.
- Even if Intel CPU shortage is true and affecting Micron, this means poorer demand.
- If Micron is building inventory now, this probably will lead to oversupply in CY2019. This would likely drive prices lower.
- Higher CAPEX weighs in on operating cash flow. In turn, this forces depreciation expenses to increase, which drives EPS lower.
- NAND prices are falling.
- The already-below EPS estimate is with a 1.2bn sharecount, which is not taking into account the buyback. With $1.5bn in buybacks this quarter (assuming a share price of $45), we still have 1.166bn shares outstanding. Adjusted for GAAP diluted EPS, we are still NOT up to analyst estimates.
- Management states that weak guidance is due to CPU shortages on behalf on Intel, tariffs, and higher taxes instead of being due to weak demand.
- DRAM supply/demand outlook appears to be very healthy. Micron says that accelerating supply growth worries are overstated and that DRAM bit growth should be 20%.
- Though NAND prices are falling, this accounted for only 13% of revenue and sales increased by 30%.
- Network Business Unit is very strong. Revenues nearly doubled YoY. Nvidia chose Micron as a partner for GDDR6 graphics alongside Nvidia’s new TRX GPU.
- Mobile Business Unit revenues rose 60% and are expected to rise further going forward.
- Micron is spending $10.5bn +/- 5% for CAPEX in 2019. Would a company who is expecting a decline in demand want to expand their business? No.
- Though ASP may decline, production costs are declining as well and should offset the price.
- Micron is going to actively buyback their stock up to $10bn. Dave Zinser stated that Micron will actively spend “at least $1.5bn on programmatic stock repurchases this quarter and could direct additional funds towards opportunistic repurchases.”
- Micron is also using their FCF to pay down debt. This is never a bad sign.