Micron Was Obliterated

Summary:

• Micron Technology, Inc. fiscal Q1 earnings were very mixed.
• Expectations are everything.
• Valuation cues from the last few downturns provide some clues as to where Micron Technology stock will bottom, assuming $50 per share or so does not hold.
• We see a turn happening in late 2023.

There is no doubt from either bulls or bears that the semiconductor sector has been demolished. The former believe we are at long-term value levels, while the bears see massive headwinds ahead for a few more quarters as we dip lower into the down trough of a semiconductor cycle. In short, there are enough chips, and many end users over ordered, and this has hurt demand. Pricing is also an issue in the sector because of this meaning less revenues on each unit moved. There is reason to take issue with the sector because of this, but let us also keep in mind that the market has largely priced a ton of this in here as a sector, but individual names are very mixed.

One popular ticker among our traders and members is Micron Technology, Inc. (NASDAQ:MU). Unfortunately earnings expectations for 2023 suggest losses. We think a best case scenario is a breakeven year. So, we could see much further price erosion in shares if we cannot see light at the end of the tunnel. Micron itself has set lowered its bar, as in November Micron gave a pretty dismal business outlook for its 2023 fiscal year. The company cut its production plans for chip wafers used in both NAND and DRAM memory by 20% compared to its levels in the its fiscal fourth quarter, and also said it also expected to cut spending in various areas across the company.

Cutting expenses can help the bottom line, but we want to ensure it does not cut into growth. Well just now we got a very timely update from the company with the release of its fiscal Q1 earnings. In this column, we discuss the key results and what we see as happening in the name and offer the perspective of a painful stock for longs as performance has been obliterated.

Micron stock could easily get cheaper

When Micron first fell to $50 a few months ago, we were in the camp that believed the stock had become attractive for tradeable bounce and we indeed were able to see some quick returns as a trader, but now we have reverted back to the $50 level. If this cannot hold, we are going much lower.

Folks, the key metrics are simply still on the decline. It is a fact, regardless of if you are a bull or a bear. The company is likely to lose money here this year. So, a “cheap stock” could get cheaper, especially if bearish predictions for chips/memory play out. Obviously, the market is trying to figure out where earnings could go after this downturn, but the fact is some companies are simply better in the space.

Micron is a fine company, but an investment here relies on the thesis that the bottom is close. So, shares have sold off for months, with a few trading bounces, and here we are at the end of December 2022, and it looks like the market got this right. The reality is both DRAM and NAND pricing were hit hard by the rather cyclical nature of the sector. Adding fuel to the fire, we saw analysts release downgrade after downgrade, mostly citing the same issues that were already known.

Expectation versus reality

Stock picking over the medium- to long-term is really a game of expectations. More specifically, it is a game of finding names that can outperform expectations, time and again. Expectations grew too high for Micron post-COVID, and just as quickly reality set in over the last year period as the company’s performance dwindled relative to lofty expectations. Make no mistake: performance, as a company, is simply challenged thanks to a tough macro space.

This chart is ugly, though it has suggested $50 is a key level of support, but there just is not an earnings basis to back this level up. It is from a chart perspective only. Frankly, the technicals mean little here, when the fundamentals are in such tough shape. There were a few positives, but the things is, we have changing expectations.

Expectations, performance relative to expectation, and new expectations, are everything for Micron

So you might be reading this little heading above thinking that our reasoning is not unique to Micron. You would be correct. For the most part, what happened to Micron can happen to any stock. While multiples vary, and it may not seem fair that the stock traded so cheaply on a multiple basis, it comes down to those expectations, and they have been continuously ratcheted down. Let us talk about new expectations and what we are looking for here following the performance in fiscal Q1.

When the company reported its fiscal Q1, there were no surprises in the results really. Revenues were expected to be around $4.1 billion while adjusted earnings per share were expected to be a loss of $0.02 per share. The company performed worse than expected, with revenues that were $4.09 billion with adjusted earnings per share of a loss $0.04. So, that is poor performance right? Well, yes, it is a worse than expected performance. Relative to expectations, it is pretty bad.

Micron Technology President and CEO Sanjay Mehrotra stated:

Micron delivered fiscal first quarter revenue and EPS within guidance ranges despite challenging conditions during the quarter. Micron’s strong technology, manufacturing and financial position put us on solid footing to navigate the near-term environment, and we are taking decisive actions to cut our supply and expenses. We expect improving customer inventories to enable higher revenue in the fiscal second half, and to deliver strong profitability once we get past this downturn.”

This hits some high points. Other key results to be aware of are moves they are making with their expenses. CAPEX is huge. This is key. Inventory is high, memory pricing is down. We are pleased to see that a move to reduce inventory is underway. $2-3 billion is what we were looking for, but were guided to be XXXX. That follows labor cuts, and other controls already taken. But many competitors have not done this. That is something to consider.

But we have a new set of expectations looking ahead, and that is why the stock may fall more. However, if it can deliver on these expectations and improve its outlook, then we will move higher. It is mostly that simple, but then, of course, you have to factor in the pain that stems from the overall market, which we do believe is largely overvalued and set to fall in H1 2023.

Fiscal Q2 looks like it is going to be rough for the stock, but is getting serious about spending, with it looking to cut 10% of the labor force. Based on what the company is saying, revenue will fall to approximately $3.6 billion to $4.0 billion, and we are expecting revenues to be under $3.75 billion. We were hoping for margins to be above 25%, based on the fact that management had telegraphed it is looking to control expenses to help offset the declines, but the degree remains unclear. Margins were 22.9%, helping lead to a big earnings miss.

That said, Micron management now expects margins of 7.5-8.5% for Q2. Horrible, though our bias is narrower at 7-8%. Given our margin expectations and revenue range, we are looking for earnings of a loss of $0.65 to $0.75 for fiscal Q2. They are reducing wafer starts by 20% to help battle inventory. That is actually great news, even though revenues will suffer near-term.

As we can see here, sales volumes declined big time, and both DRAM and NAND saw ASP fall in the low 20% range from the sequential quarter. Ouch.

Again CAPEX was huge for us, we were awaiting this, and was $2.47 billion for the first quarter of 2023, which resulted in adjusted free cash flows of a loss of $1.53 billion. Micron repurchased approximately 8.6 million of its shares for $425 million. It ended the quarter with cash, marketable investments, and restricted cash of $12.08 billion, for a net cash position of $1.81 billion. CAPEX for the year will be reduced to $7.0-$7.5 billion. That is bullish.

For those keeping score, this is a disaster relative to Q2 2022, which saw $2.14 in earnings and $7.79 billion in revenues. We are not overstating our reduced expectations as a disaster. It really is a disastrous turn. Again, while the sector is under pressure, you can still pick winners and losers. Right now, MU is in the former camp, but we do think and fully expect a turn in performance in late calendar 2023, which brings us into fiscal 2024. While this will be data dependent, assuming this turn does occur as we expect, shares should start to rebound in the spring time more meaningfully. The company may be faster approaching a trough in this downturn. The stock actually held up pretty well so far following this report, but we will see how it behaves in tomorrow’s session

When will it get better? Over at our service, we have been discussing a turn for the sector by calendar Q3 2023. No one knows for sure, but we are estimating a bottom in performance by then for the sector. We talk about the Fed, and will say we think that we are talking about interest rate cuts in late 2023, which will help tech stocks, significantly. Look Micron is cyclical, and if we look back past downturns in the last two cycles, lower lasted a year and a half, maybe two full years looking at EBITDA margins. Looking at earnings, we are talking 6-7 quarters. So, considering peak performance was in fiscal Q3 2022, we would expect a ramp up in late calendar 2023 at the earliest. In short, we are likely to see more pain ahead before it gets better. but shares should start to move higher before performance actually does turn, as expectations will improve.

MU is going through a downturn, which has happened before, and the stock will likely see more downside in 2023, before ramping up, especially if earnings or margins expectations are revised lower in the next quarter or two. In the last month or so, earnings revisions have pretty much consistently been lowered 20%.

Let’s talk a little value.

From a P/E perspective, Micron looks cheap, but that is because earnings on a trailing basis were high. A trailing P/E of 6X is cheap but only if forward earnings will grow. But earnings are going to fall, and be negative. So we can look to other metrics in the interim. As trailing-twelve-month earnings come down, the multiple will expand again each quarter. If we look at a price-to-sales basis, or better yet, the price-to-book (tangible), we can get a better sense of a true bottom. The latter saw bottoms under 1.0X in the past few cycles, and currently, it’s over 1.1X, so one would expect further declines before a true bottom. This is what we expect. We also think the stock is somewhat cheap on a price to cash flow basis (3.6X) but FWD price to cash flow is worse as performance will dip (7.7X). Please note these figures will adjust should get worse as expectations play out. It can get cheaper, but not by much to the point it is “ridiculous,” unless expectations are further revised lower. That is the key.

Final thoughts

The quarter was mixed, at best. But the outlook is what really mattered and we are looking for some serious losses in Q2. Shares are up marginally here, but we think that $50 is a chart level that needs hold, but is unlikely to be maintained if expectations get any worse and frankly the outlook was poor. But the serious cost-cutting moves are what could save Micron stock as investors simply wait for the macro position to improve.

Overall, we think there are better players in the space, despite the fact that we do love to trade Micron stock. That said, we do embrace long-term investors using a buy-write strategy here to generate some income while building a position in Micron Technology, Inc. ahead of a turnaround.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

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