The S&P 500 has pulled back a modest ~5% since its all-time high reached in late January. With the 10-year T-Bill finally surpassing 3% and two additional FED rate hikes expected this year, it becomes continually more evident that the United States is in the late stages of the current economic expansion. As the FED begins its ‘cooling’ procedure of raising rates and effectively increasing the cost of capital while also tempering inflation, the market reacts accordingly and pulls back modestly, given the FED acts within the realm of expectations.
So if you have cash, what do you do? Maybe you’re sick of watching the markets run up and want to participate while protecting yourself. Sure, you can hold out if you’re particularly risk averse, or play defense and purchase a 10-year for under 3%, if you’re content with that return. Or, you could look for an opportunity in a “perfectly efficient” public equities market. But the whole point is that doesn’t exist, right?
Under market conditions with valuations near their highest levels, I begin by looking for something with a reasonable valuation in comparison to peers. According to several metrics, Micron Technologies (MU) trades at an attractive valuation relative to its closest competitors. Micron is a $60 billion semiconductor developer and manufacturer with a P/E below 7. For some perspective, one of its largest competitors is Nvidia (NVDA) with a PE of ~45. NVDA’s price-to-cash flow is ~40, Micron’s is 4. NVDA’s price-to-sales is 13, MU’s is 2. NVDA’s price-to-earnings growth ratio is 3.4, MU’s is 0.5. Of course it is an oversimplification to invest simply based on relatively attractive valuation, especially versus one competitor, but nonetheless I wonder why MU’s valuation is so low. Why does the market view this company like a ship with a massive hole right below the waterline?
It begins with the industry. Analysts from multiple firms believe the semiconductor industry is highly cyclical, and that we’re near the apex of that cycle. I cannot disagree with the cyclicality of the semiconductor industry; investment in tech fluctuates greatly over economic cycles. But how is it that we’ve reached peak demand when every car coming out of the factory will have autonomous driving capabilities within the next decade, and thus a fundamental need for high processing capabilities? Given cloud computing that is really in its infancy, how can you argue that DRAM sales are likely to peak? If you ask me, demand for MU’s products has a long way to grow.
The market also doesn’t love the fact that MU is better known for manufacturing more traditional hard drives, hardware that while advantageous for its capacity, is being rapidly replaced by solid state drives for their speed, durability, and silence during operation. But wait, Micron’s SSD sales are up 80% YoY. If you think they aren’t following the trends of the markets and innovating, think again. As smartphones grow in their capabilities, they require more NAND storage. NAND sales accounted for 25% of MU’s revenue in FQ2-18, and increased 28% YoY. DRAM, storage for cloud, contributed 71% of MU’s revenue in FQ2-18, and sales in that segment are up 76% YoY. Non-GAAP gross margin in this product line improved from 44% to 66% YoY. Even MU’s bread and butter industry is improving significantly in margins.
Then there’s their debt. Sure, they have some long-term debt. But over the last 12 months, those levels have nearly halved as cash has nearly doubled. Seems like a good trend to me. The face value of debt at the end of FQ2-18 was $9.5 billion, a manageable level for a company with MU’s position in the industry and current liquidity. Any other reasons to dislike on MU? Until I can find one, I am long the stock in a market that I think has little value to be found.
McCann Investments 