Micron Technologies (MU)

A Brief History Lesson

As with many investment opportunities, the history of the company poses just as much importance as the projected future.  Understanding the intricacies and previous challenges Micron has faced within the last decade provides us with a digestible understanding of how shares of this company arrived at an attractive price. That being said, leaning into research with this particular investment idea was originally equivalent to sifting through muddy river water for gold.  It was dirty, monotonous, unappealing, and no doubt seemed at times pointless until a complete understanding of the situation provided me with (hopefully) a gold nugget and then some.

You see, Micron has been deservedly forgotten by investors for some time now. Micron is the producer of both DRAM and NAND memory chips, however, it is the DRAM industry that poses their biggest financial opportunity. More on that later.

It is important to note that memory chips as a whole differ wildly from what a majority of people refer to as “chips” when referencing companies such as Taiwan Semiconductor (TSM), Advanced Micro Devices (AMD), or Intel Corporation (INTC).  Those mentioned prior primarily specialize in creating logic chips, which serve to effectively and quickly process incoming data within any device.  Inside the logic chip industry, what has taken to headlines recently is the design aspect of these chips.  Companies are continually attempting to make their chips not only perform more quickly but also do so at continually smaller sizes.  Because the nature of this industry is so heavily reliant on consistent improvement of products, a majority of the players focus solely on design and outsource their manufacturing.

In contrast, the memory chip industry specializes in creating chips that are capable of storing data within a device for either long or short periods.  The arena requires companies to not only design their chips but also manufacture themselves as well.  To put bluntly, memory chips feed data into logic chips to be processed.  The two work in tandem with one another.  Earlier within the last decade, a majority of the playing field within producers of these chips consolidated into a few key players, and gross margins were poised to rise with an easy road to higher rates of profitability looking likely.  Then demand fell.

More specifically, this did not come about from negligence but rather beginning sometime in late 2016, the demand for PCs fell within retailers by about 10%.  This resulted in a reduction of demand within the DRAM industry of about 20%.  Subsequently, there was an unforecasted over-production of memory chips and since it takes quite some time to retool essentially an entire industry, the market became saturated and prices for DRAM plummeted.

Unsurprisingly, the share price has been rather stagnant since 2018 as three major players (Micron, SK Hynix, and Samsung) attempted to counter the unforeseen overproduction.  While for quite some time it was to the advantage of each of these players to operate alone in attempting to develop superior products, such is no longer the case.  The incentive to create innovative memory chips has all but vanished, as the cost to add memory capacity to the current-sized chips far outweighs any reward that could be gleaned.  Such is the law of diminishing returns.  Ergo any future growth would come from further increasing manufacturing proficiency and demand collaboratively rather than trying to snuff one another out.

Where do we stand today? 

As cash has been poured back into Micron’s business to respond to the decrease in demand, Micron’s memory chip production today is composed of approximately 75% DRAM and 25% NAND.  Think of DRAM as a form of short-term memory that can be found in both computers and increasingly in mobile phones whereas NAND is geared more towards long-term memory such as the ever less important flash drive.  As long-term data storage has evolved over the years, NAND has less potential to be as profitable as DRAM within the coming years in my eyes.

DRAM has historically been viewed as a commodity and as such is often profitable in a cyclical nature.  Today, the ever-increasing shift towards a variety of new technologies that require more and more data also naturally requires more and more memory.  To name a few; the advent of artificial intelligence, newly implemented 5G handhelds, and even the useful albeit annoying habit of a company collecting data from users require memory to eventually process it and do something useful.

Data itself nowadays is viewed as almost being just as useful as the consumer itself.  Data allows a business to customize, project, tailor, and evolve for its existing user base as well as the future.  Without the capacity to store and eventually process information, data collection is relatively pointless.  While the whole world has been increasingly narrow-sighted on the developments of logic chips, the consolidation of the memory industry has gone relatively unnoticed as well as their necessity in the coming future.  Therefore, it stands to reason that demand for DRAM will be increasing in the future as opposed to the recent oversupply.

Micron is in an interesting position that allows it to benefit the most not only from the incentivized cooperation but also from the increase in demand for its products.  Historically, Samsung dominated the market by taking up an exorbitant amount of the memory market at one time. Market dominance allowed Samsung to maintain a cost advantage over other players. This was possible due to their extensive amount of free cash flow from their other operating activities that could be directed into developing better chips.  Similarly, SK Hynix benefited from this esoteric practice as well.  As the physical limitations of this practice were neared, and other memory players consolidated into cash-intensive businesses, the motive for this practice has all but vanished.  No one stands to benefit more from this disappearing moat than Micron Technologies.

Future Projections

The increasing demand from secular trends as well as decreased incentive for high levels of competition serve to increase Micron Technologies profitability.  I foresee this as being accomplished twofold.  The first is that Micron’s balance sheet will benefit highly from this scenario.  Not only will they experience a greater level of sales which will increase revenue, but also reap higher profit margins from the decreased level of competition from a few competitors.  Secondly, Micron is currently trading at a low enough multiple that an increase in earnings would likely influence the multiple that it trades at as well.  These two changes will likely serve as the twin engines that send the Micron share price soaring.

Key Risks

Micron has a lot of moving parts within its business.  It is this exact reason why the price has been stagnant as the company and the market it plays in have undergone several changes that benefit the company itself.  The resulting price is attractive no doubt, but there are several ways in which this thesis could be unraveled.

1. New technological breakthroughs would easily erase any competitive advantage Micron may see in the future market.  If chips were once again able to be improved in a way that incentivizes competition, companies again would revert to throwing cash at a wall hoping that a design sticks.  Alternatively, there could be an unknown revolutionary product developed that could render DRAM and NAND useless in the coming years.

1. Management plays a crucial role in the performance of any company.  While I do have faith in Micron CEO Sanjay Mehrotra to navigate this new territory, there is always a chance of botching the job.  Rather than focus on production meeting demand, we could potentially see another oversupply of memory due to greed and mistiming of the market.

1. Another Player would no doubt throw a wrench into this game.  Micron is the only of the three largest oligopolies to be U.S.-based, and as such I do not see any internal domestic competition arising soon.  However, the development of another company with enough memory production capacity would trim away at Micron’s projected margins.

Conclusion

Given all of the above, earlier this year Virtue Capital Group established a sizable position within Micron technologies.  I see this as an opportunity that fits our criteria for a lot of potential for upside with little chance of loss.  A true “high reward, low risk” scenario that proved too tempting not to take a bite out of, I’m excited to watch this thesis play out as time progresses.