Last December, we highlighted Micron (NYSE: NASDAQ:MU) was getting expensive, as the company’s share price moved towards $100 / share. In April, at $75 / share, we wrote investors should begin to take a look, stating “…implying a $54-61 per share range to begin investing”. As we’ll see through this article, with the recent price weakness, we recommend investors begin investing in Micron.
Micron Market Opportunity
There’s no denying that Micron operates in a massive and modernizing market.
Memory consumption across nearly every use case is growing exponentially. Natural language models in AI are using terabytes of memory to support their operations. Mobile phones needing to support 5G and other intensive operations and data based activities are seeing DRAM averages increase significantly.
Self driving cars require 100s of times as much compute as your standard car which already has a significant number of electronics. DRAM and NAND bit demand is expected to grow by the double-digits % annually, and from a revenue perspective, the DRAM+NAND market revenue is expected to more than double from 2021-2030.
At the same time, DRAM, an industry whose capital requirements traditionally regularly caused bankruptcies, has seen massive consolidation forming an oligopoly of sorts.
Cross-cycle average gross margins for the industry have doubled for the CY2014-2021 period versus where they were in the CY2006-2013 period. In the same time frame, wafer fab equipment spend as a % of EBITDA has been cut in half almost to recent levels of roughly 30%. That has enabled companies to improve their balance sheets considerably.
In true oligopolist fashion, the few remaining memory producers don’t want this to change. Micron has guided to continue growing supply in line with demand growth versus attempting to gain market share, and its competitors are lining up. These industry-wide improvements in a growing industry are a bedrock of the thesis for a long-term investment in Micron.
Micron Capital Requirements
Micron already has a tough to replicate portfolio of assets. The company has estimated the replacement value of its assets at roughly $100 billion with 50,000 patents to protect those impressive assets.
However, ramping to new products, improving technology, and scaling bit growth are all expensive. The company expects that to maintain supply growth in line with industry demand (i.e. maintain its market share) it’ll have to invest $15 billion in capital expenditures annually. That’s substantial for a company with $30 billion in TTM revenue.
However, it’s worth noting by the end of the decade, that should grow towards $60 billion given the company maintains the same market share in the growing market. That means going forward, the company will continue to pay the largest share of its earnings towards capital expenditures, restricting its theoretical cash flow.
On the bright side, the oligopolistic nature of the memory market means the company is likely to achieve its goal of maintaining market share and the accompanying revenue.
Micron Shareholder Return Potential
With minimal debt, we expect Micron to be able to generate modest and reliable shareholder returns over the coming years. The company recently announced an increase in its dividend towards roughly 1%, forming the basis of its cash flow.
Micron has provided guidance that helps us predict the company’s shareholder returns. The company expects $150 billion in capital spending over the next decade with a target for that to be ~35% of revenue. That implies roughly $430 billion in revenue over the next decade, although like capex, we expect it to be back weighted.
The company has also announced a target for a >10% FCF yield as a % of revenue. That means that on the lower end the company should see (as an average) roughly $4.5 billion in FCF annually, implying a roughly 8% FCF yield across the decade. That might seem simply like market average, however we think there’s two other advantages here.
First the company will continue growing. It won’t finish the decade as a stagnant company forever doomed to return 8% in FCF, but it’ll see that number continue ticking up in the long run. Second, the company, especially as current levels, we expect to be aggressively buying back shares. The less shares outstanding early on the higher the end of the decade returns are.
Current levels represent roughly where we recommend to begin investing in Micron, and we like it at current levels or lower.
The largest risk to our thesis is the volatility of the memory markets. Even with lower competition, and less of a build at all costs mentality, the industry still remains capitally intensive with commodity-like pricing as demand varies. Fluctuating prices could place strong restrictions on the company’s ability to drive continued shareholder returns.
Micron has seen its share price suffer, however, the company is finally positioned at what we view as fair value, which will enable it to continue providing shareholder returns. The company is a buy at these levels and a strong buy if prices drop going forward, with the ability to drive high single-digit shareholder returns.
The company expects to continue maintaining its market strength, with substantial capital investment. The market is a volatile market but the increased consolidation and bankruptcies in prior decades, means we expect the boom and bust cycles to taper. Micron itself isn’t chasing shareholder returns.
We recommend investing in the company as a steady reliable investment on the basis of its high-single digit returns, and ability to utilize that cash to generate additional long-term shareholder rewards in a growing industry.