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Does Micron’s (MU) Stock Price Fairly Represent Capital Returns?


To find undervalued companies, we ran a scan for companies that have a low P/E ratio through our Stockmetrix app, and we came across Micron (MU). The current P/E of 4.29 stood out in stark contrast to the much higher multiple of S&P 500 of 20.7x and the 5-year average of 16.5x. So is Micron a value or a trap?

Top and Bottom Line Returns Would Say It’s a value

Micron Technology Inc. (MU) grew topline and bottomline results at double digits during the last two fiscal years.

  • Revenues increased from $12.4 billion in 2016 to $20.3 billion in 2017 and $28.1 billion for the TTM.
  • Gross margins have increased from an average of 23.55% during the last five fiscal years to 41.5% in 2017, 56.4% in the TTM, and guidance between 57% and 60% in 2019.
  • Cash flows from operations has increased from $3.1 billion in 2016 to $8.2 billion in 2017 and $15.5 billion for the TTM.

The company currently ranks third in DRAM market share, after Samsung and SK Hynix.

With Samsung being a more diverse company, SK Hynix provides a better comparison. Profitability and efficiency ratios show a very tight correlation except in one regard, PE. Micron’s PE is lagging 52% behind SK Hynix.

With all this financial success, why has the share price not experienced similar success?

A Cyclical, Commodity Business With No New Story

Micron operates in a highly competitive and cyclical subset of the Semiconductor industry with very little product differentiation. The commoditized memory/storage products make the company vulnerable to both pricing pressure, which usually tracks downward over time, and supply and demand imbalances.

All of the above suggests a low PE for the overall Semiconductor subset. Yet, why does Micron fall behind its peers?

Analysts voice concerns Micron continues to fail to expand its products. The company has two major lines, DRAM, which accounted for approximately 64% of total revenue, and NAND, which accounted for 31% of total revenue in the fiscal year 2017. SK Hynix has very similar revenue concentrations to Micron but executes better on the bottom line.

  • SK’s gross margin sat at 57.81% for 2017 and 61.33% for the TTM.
  • Micron’s margin moved above 40% in 2017 and rests at 56.43% for the TTM.
  • 2019 guidance for Micron comes in between 57% and 60%.

Returning Value to Shareholders

There are two ways of increasing shareholder value: buybacks and dividends. Since the company has not been able to shed its cyclical/commodity story, management initiated a buyback program of $10 billion. The buyback program announced on May 21, 2018, consists of a discretionary repurchase of up to $10 billion of its outstanding common stock, in conjunction with plans to return at least 50% of free cash flow to stockholders beginning in fiscal 2019. Micron wants to take advantage of the current market conditions and increase their stock price levels close to the fair value for the company. However, with limited product offerings, the company fails to present a path to a sustainable long-term growth story.

Valuing the Company from Dividends

As investors, we want to look at the company from various angles to determine its value. Dividend cash flow models present a good way to derive a share price.

Even with a cyclical business and a decline in sales from current levels, Micron can sustain a dividend yield between 1.5%-2.0% while maintaining current levels of CapEx. For reference, the buyback program and shareholder distributions amount to approximately $10.15 per share, which is higher than six years’ worth of dividends.

Under the multi-stage dividend discount model, dividends for years 1-6 amount to $9.31 per share. The model considers a 2% dividend yield, cost of equity of 10%, and an overly aggressive perpetual dividend growth rate of 5% to calculate the terminal value.

Even with an aggressive approach, the dividend discount model reflects an estimated share price of $28.64, which approximates the company’s current tangible book value per share of $27.84.

Furthermore, a closer look at the company’s valuation metrics compared to the Semiconductor sub-industry results in the company being overvalued by 5.26% to undervalued by 22.22%. This is a far cry from the S&P fair value estimate for MU at $102.96.

So why the low P/E? Consider the company’s net income over the last 10 years:

Given the cyclical nature of the business, along with the commoditization, the market views the high amount of net income as temporary, rather than sustainable. Using the volatile net income as context, if you averaged out the NI over multiple years, you’d have a P/E that is well into the double digits.

Conclusion

The share price of Micron reflects little confidence from the market that the company will diversify their portfolio. Rather, share prices indicate the company only plans to continue forward in a sector that is cyclical, commoditizing and declining. Investors can still assume a floor around $30 in the share price, with potential upside possible in both performance and a change in strategy. Should the company choose to redirect capital towards expanding their product lines beyond computer memory, they could replace what is likely to be a decreasing cash flow stream in the coming years.

 

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