- Memory producers are cutting supply to help increase profits.
- Historically, the time to buy memory stocks is when client inventories begin to normalize, DRAM/NAND price drops start to slow, and consensus 12-month EPS estimates stop coming down.
- Catalysts include a memory upcycle, industry consolidation, and China restrictions on Micron’s competitors.
You wouldn’t know by looking at their latest quarterly report, but a deeper dive shows that now may be a time to consider Micron (NASDAQ:MU). As a cyclical stock, Micron is best bought when the industry appears to be bottoming, which may be occurring right now.
Micron’s latest Q1 2023 earnings had a loss of $0.04 on revenue falling 46.8% to $4.09B. DRAM and NAND prices plunged a low-20%. Q2 guidance came in even worse at $3.8B in revenue and a loss of $0.52-$0.72. It’s safe to say the memory sector is in a difficult position at the moment as clients have significantly slowed their purchases and are instead focused on working down current inventory.
The DRAM industry is represented by three suppliers, Micron, Samsung (OTCPK:SSNLF), and SK Hynix. The NAND industry has the same three suppliers in addition to Kioxia, Western Digital (WDC) and YMTC. In response to the high inventory, the memory suppliers have announced large supply cutbacks. Micron, SK Hynix and Kioxia all announced supply cuts, while the largest supplier, Samsung, was a bit more ambiguous. They announced that they will keep capex the same, but shift more of that toward research and development.
With less of their capex going to actual production, analysts are expecting Samsung to have 9% less shipments this year. The supply cuts should go a long way in shoring up the memory market. In fact, equipment supplier Lam Research is seeing unprecedented reduction in orders from memory clients. Lam CEO, Tim Archer, stated
“We’ve seen extraordinary measures within the memory market. As a percent of total WFE, memory is at levels that we haven’t seen in 25 years.”
Micron has been very aggressive with their production cuts, originally announcing a 50% cap ex cut and later also stating they will cut wafer starts by 20%. South Korean competitors (SK Hynix and Samsung) have also seen a large production drop.
Signs of the Cycle Bottom
Historically, the time to buy memory stocks is when client inventories begin to normalize, DRAM/NAND price drops start to slow, and consensus 12 month EPS estimates stop coming down. Let’s look at each of these.
Supplier inventories are currently at record levels with Micron’s days inventory outstanding at 215 days. Samsung and SK Hynix are also at 2-3x healthy inventory levels. However, the memory sector usually bottoms when client inventories normalize, not supplier inventories.
Client inventory is admittedly difficult to get a view on and one reason why the memory sector is cyclical with producers often failing to recognize when clients have been double ordering. It is also the reason why the stock price should have significant appreciation when clients resume their purchases – it will be a sign that their inventories are normal and remove a significant unknown in the market.
The difficulty with predicting this is that if you wait for an all-clear, Micron will have already significantly appreciated. Some things to consider, though, is that past client inventory corrections took about one year and this time it has been going on for about a year, also.
Expectations for improved client inventories are also starting to be shared. Micron CEO Sanjay Mehrotra said that he expects healthy client inventory levels by mid-calendar 2023. South Korean reports align with this, also:
Memory inventories at server producers in North America and smartphone makers in China are projected to drop 25% QoQ in 1Q23, which would mark the first time in a year. In addition, inventories at memory producers are expected to turn downward starting in 2Q23. Accordingly, we are likely to see customers’ inventories normalize and memory producers’ inventories return to healthy levels from 3Q23.
Memory Price Drop Slowdown
The second feature that helps to signify memory cycle bottoms is a slowing down in ASP drops for DRAM and NAND. Trendforce came out in January with their expectation that Q1 NAND ASP will be down 10-15%, less than Q4’s 20-25% drop. They also predict DRAM in Q1 will be down 13-18%, also less than the Q4 drop of 20-25%. Trendforce believes NAND prices in March may level off or decline slightly.
A lot of the expected downturn has now been priced into Micron estimates, as downward revisions have slowed. According to Yahoo, analyst expectations 90 days ago was for Micron to earn $0.31 in 2023. 60 days ago that had a large downturn with expectations falling to a loss of $1.53. The current expectations are for -$1.92 which is not far from where analysts were 30 days ago (-$1.89).
It’s clear that EPS expectations have begun to drift sideways. Reports are coming that healthy client inventories and slower reductions in memory pricing may be just around the corner.
The biggest catalyst for Micron shares is simply the emergence of the next upcycle. The signs for a bottom are materializing and I expect in the next few months, the signs for the upcycle will appear. The recent excitement over AI may accelerate not only the timing of the upcycle but also the size.
Another possible catalyst will be further consolidation in the NAND industry. Intel recently sold their NAND operations to SK Hynix to bring the total NAND market down to six suppliers. Restrictions on Chinese memory companies have basically stopped YMTC’s progress and there are currently rumors that Kioxia and Western Digital may merge, leaving potentially four NAND suppliers. The fewer suppliers, the easier it will be to manage supply.
Chinese restrictions may also cause another positive catalyst for Micron specifically. Its two main competitors, Samsung and SK Hynix, operate plants in China that are in the crosshairs of US sanctions. To prevent China from developing advanced semiconductor chips, the US has limited exports to China to prevent them from manufacturing DRAM chips of 8nm or less and NAND chips of 128 layers or more. SK Hynix has a DRAM plant in Wuxi that creates 50% of their DRAM. They also have a NAND plant that they bought from Intel in Dalian. Samsung’s factory is in Xian.
When the United States announced the China sanctions in October, they gave SK Hynix and Samsung a 1-year grace period which they can still import equipment to these plants. Recent commentary by US officials has raised the possibility that this grace period will not be extended. Others have suggested that they will be given two years. Either way, it seems to be only a matter of when, with a longer timeframe giving Samsung and SK Hynix more time to contingency plan.
If the import of needed equipment is no longer allowed into China, SK Hynix and Samsung will be in a tough spot. They will not be able to import needed machinery and their chips will not be able to keep up with technological advancements. They will have to sell their plants or use them for legacy chips. It will be harder to maintain their equipment and productions and sales may decline. It may be especially tough for SK Hynix since the productivity gap for DRAM widens by more than 20-30% as the process node lags behind by one or two generations. While this could hurt SK Hynix, it will be beneficial to Micron as 69% of their revenue is from DRAM.
Micron has had a rough 2022 as the stock price reflected the downturn in the memory chip cycle. However, this downturn may be close to bottoming with signs starting to show. It will be important to continue monitoring the three items that have signaled past cycle bottoms. This includes client inventories normalizing, memory price drops slowing down and EPS estimates drifting sideways. In the past few cycles, Micron has taken out its previous cycle high and, with all the emerging trends that need memory chips (AI, automobiles, etc.), I expect the same in the next cycle. Last cycle Micron had a double top in the mid to high 90s before it started its descent. This time we have now seen a double bottom. It appears to have a great risk-reward setup. Whether the cycle will take a U-shape or a V-shape, historically buying Micron at a cycle bottom has proven to be a great buy.
Disclosure: I/we have a beneficial long position in the shares of MU 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.