Micron: CHIP Grants Are Rocket Fuel (Rating Upgrade)
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Summary:
- Micron Technology, Inc. is set to benefit from a U.S. government grant, which will boost its competitive stance in high-margin, high-demand areas such as AI applications.
- The company’s recent developments in AI DRAM utilization and partnerships with Nvidia for HBM3e memory for AI GPUs are expected to drive sustained growth and profitability.
- Micron’s commitment to building chip plants in New York and Idaho, supported by government incentives, will strengthen the U.S. semiconductor supply chain and position the company for long-term success.
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Investment Thesis
As global tensions have heightened, demand for a secure and advanced semiconductor supply chain have grown, and I think Micron Technology, Inc. (NASDAQ:MU) is rising to the occasion. I believe the U.S. government’s recent $6.1 billion grant for Micron will boost its competitive stance in high-margin, high-demand areas, especially AI applications. Its commitment to build chip plants in New York and Idaho will benefit U.S. strategic initiatives aligned with the burgeoning demand in AI and high-performance computing for commercial and defense applications. In my opinion, this will be rocket fuel for their business.
In this regard, while the company has gone through its share of chip cycle booms and busts, I think investors can now more heavily rely on Micron’s sustained growth and profitability in the coming quarters, on the back of the company’s recent developments in AI Dynamic Random-Access Memory (DRAM) utilization and partnerships with Nvidia (NVDA) for high bandwidth memory (HBM) HBM3e for AI GPUs. Coupled with U.S. grants lowering the capital equipment costs of the memory giant, and I am optimistic about the company’s outlook.
With this, I’m upgrading Micron to a strong buy after my previous coverage. Government incentives pave the way for much higher revenue and profits (another place to offload capital expenditures), and I believe moves higher in the stock eventually as more industry analysts suggest that the market dynamics for DRAM will gradually shift favorably towards manufacturers (like Micron). Micron is in a better position to catch up with its competitors, with 71% of its $21 billion total revenues coming from DRAM chips last year. The market reliance on DRAM chips today will be matched by adjustments in production levels that have helped realign supply with current demand levels, buoyed by recovering prices of DRAM.
Why Am I Doing Follow-Up Coverage
Before their Q2 2024 earnings, I wrote that Micron’s significant depreciation expenses through their extensive capital investments have put a huge dent on the manufacturer’s financial performance and place a drag on the company’s operational performance. In addition, the market downturn in the past two years affected the demand for DRAM chips due to a slowdown in the PC, consumer electronics, and smartphone sectors. However, market dynamics point to an upturn in DRAM pricing throughout 2024 to favor memory manufacturers such as Micron.
Post earnings, my lingering depreciation concerns for the company are mitigated by the U.S. government’s grant that will bolster their U.S. supply chain and production capabilities. This support helps alleviate the financial burdens associated with scaling and modernizing DRAM production by lowering manufacturers’ capital outlay for future projects. Micron’s heavy depreciation costs will be partially addressed by the enormous grant (and more that may be to come) to revitalize the U.S. semiconductor industry, which is why I am upgrading the stock to a strong buy.
Background
The semiconductor industry has faced significant supply chain issues, particularly highlighted during the global shortage that emerged during the COVID-19 pandemic. This highlighted how the global community’s dependency on fabrication facilities (or fabs) primarily located in Taiwan, South Korea and China, which are highly vulnerable to disruptions. A brief delay at a manufacturing facility in Taiwan could trigger a chain of supply issues lasting nearly a year.
In response to these vulnerabilities, the U.S. government has decided to support rebuilding the country’s domestic production capabilities and reducing reliance on foreign chip manufacturing through the CHIPS and Science Act.
Micron is one of the many manufacturers that have secured significant federal commitment to boost the country’s domestic supply chain. In 2022, the company announced that it plans to build a giant factory in Clay, New York, expected to be completed in 2025 through a $5.5 billion incentive package. The company also committed to spend over $100 billion over the next two decades in upstate New York.
In April 2024, the Biden administration reached an agreement to provide $6.1 billion in government support to the company to build the biggest memory chip plant in America that will create an estimated 50,000 jobs. It also plans to build a factory in Idaho using the funding.
What I Liked On The Earnings Call
Micron’s recent earnings call presented an encouraging shift from the large depreciation expenses that I mentioned above. CEO Sanjay Mehrotra highlighted that the company is now fully utilizing its high-volume manufacturing nodes, which are maximizing output against structurally lowered capacity. This will allow the company to gradually mitigate the impact of high depreciation costs on its financials.
We are now fully utilized on our high-volume manufacturing nodes and are maximizing output against the structurally lowered capacity -Prepared Remarks Before Q2 Call
During the earnings presentation, the company also emphasized the improvement in supply and demand balance driven by strong AI server needs and healthier demand environments across most end markets. CEO Mehrotra noted that the company’s HBM chips used in AI applications were sold out for this year, with much of the 2025 supply already allocated. The strong demand backlog, in my opinion, ensures the company’s financial performance against the cyclical nature of the semiconductor industry.
The company also expressed optimism in the continued uptick in DRAM and NAND pricing levels throughout 2024. Expectations of record revenue and improved profitability in fiscal year 2025 are also possible.
Current Government Incentives Are Just The Beginning
In a podcast interview with Scott Gatzemeier, Micron Corporate Vice President of Front End U.S. Expansion, he explained:
At Micron, we really consolidated the industry by acquiring assets in Japan and in Taiwan, and through those acquisitions that’s where we have our manufacturing capability. About 8% of our DRAM is manufactured in those two locations, and then we have a facility in Manassas, Virginia where we manufacture a lot of our automobile [semiconductors] and other DRAM. -Podcast Interview.
Micron will take advantage of the CHIPS and Science Act funding further after a Virginia legislative panel, Major Employment Investment Project Review Commission, approved a project grant for their Manassas facility to develop new technology for automobile semiconductor chips. Although the details of the incentive package are still under wraps, I believe that reflects the company’s bullish move following its strong Q2 2024 results. In 2021, it also announced that it is looking for partnerships with other governments to fund its global expansion.
Why This Is A National Security Play
The U.S. government’s initiative to repatriate semiconductor manufacturing extends beyond economic benefits and touches on national security implications. I believe that the funding will ensure that sensitive military and intelligence applications are supported by domestically produced and more secure semiconductors. Intel was granted a $3.5 billion funding package to produce chips specifically for military use under the same Act. The program also caters to smaller players in the industry, with the Commerce Department earmarking $500 million specifically for smaller companies for a more broad-based support structure for the national semiconductor supply chain.
I believe that, eventually, it’s most likely that future government and defense procurements will increasingly mandate U.S.-made semiconductors. Micron is well-positioned to meet such demands, along with other players that comply with stringent security requirements.
Valuation
In my previous valuation, I was concerned with Micron’s net income losses carried over from the 2022 fiscal year. Depreciation has more than offset the net income losses the company incurred since 2022 as a result of applying depreciation to the capital equipment they use.
In fiscal Q2 2024, revenue has improved on a YoY basis, reaching $5.82 billion, up from $3.69 billion or 58%. Operating cash flow came in at $1.22 billion, compared to $343 million for the same period last year. Bit shipments, another metric for demand, increased by a low-single digit percentage QoQ for DRAM but not for NAND, which recorded a slight decrease. This caused the company to be profitable, and I think hit a turning point.
Micron (with these government grants and Nvidia partnership) seems to have reached a production volume that can outweigh the heavy, but necessary depreciation costs they have to incur to continue to have cutting-edge equipment to make the next generation of memory devices. With this, I think the company deserves to trade more in-line with their forward price to cash-flow ratio.
Currently, their forward price to cash-flow ratio is 13.73, this is below the sector median of 21.87. If we saw the company’s valuation converge on the sector median, we could see up to 59.28% increase in share price.
Risks To Thesis
Micron has to contend with intense market competition after other manufacturers received funding from the Biden administration. Taiwan Semiconductor (TSM) leads these global semiconductor players in terms of size and will receive $6.6 billion to build its first major U.S. hub in Phoenix. While TSMC does not directly compete with Micron in the memory space, it’s worth noting that other memory players such as Samsung (OTCPK:SSNLF) have received government grants too.
Intel (INTC), similarly, will receive nearly $8.5 billion in funding. Samsung also became more aggressive with its U.S. investments after they secured a $6.4 billion grant.
Despite this, I strongly think Micron’s silver lining is its commitment to investing far more in the United States (over $100 billion over the next 20 years) relative to its competitors. More investments in the country will lead to many opportunities to acquire government grants, which will further help them build more net-lower capital cost factories.
Bottom Line
I believe Micron is well positioned to capitalize on its current growth phase with the projected increase in DRAM demand in AI-enabled devices and the expansion of data centers requiring advanced memory solutions. Despite the cyclical nature of the semiconductor market, Micron has demonstrated resilience by ramping up production in response to current demand surges.
Given this, I think their advancements in technology and expansion into crucial markets (Nvidia partnership) will allow it to maintain a higher level of pricing power given industry fluctuations, especially for the memory chip market after it had a strong decline in sales in 2023 at 31%. Unlike more commoditized segments of the semiconductor market, its HBM and AI-related memory solutions can withstand the harsh price competitions seen in more standardized memory markets.
Given these factors, I am upgrading Micron stock to a strong buy. The company’s strategic position, coupled with the ongoing expansion through government funding support, presents a compelling investment opportunity.
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Analyst’s Disclosure: I/we have a beneficial long position in the shares of INTC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Noah Cox (account author) is the Managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.
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