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Micron: Asymmetric Opportunity And Top 2019 Pick

To say Micron (MU) had a tough 2018 would be an understatement. After hitting an all-time high in May, the mood went from euphoria to utter despair as the stock crashed over 50 percent from its high. The fall was an overreaction, and Micron is now an asymmetric opportunity. Micron now trades for a hair above book value and has less than 20 percent downside against over 100 percent upside. For these reasons, Micron is my top pick for 2019.

Thesis

1. The company's book value now sits at $30 per share. Sure, Micron fell below book value last time during the cycle through, but their poor balance sheet at the time forced the old management to dilute shareholders with (crappy) junk convertible debt. This time around, the balance sheet is good. As of the last quarterly filing, Micron has $5.5 billion in cash and short-term investments. The company is free to use the cash as it sees fit, as they have roughly the same amount of accounts receivable as current liabilities.

2. Micron's balance sheet is in such a good position that S&P raised their outlook for Micron's debt. Micron is likely to escape junk credit status from now on, as a result of sound management under Sanjay Mehrotra and his team. Micron currently carries a junk credit rating due to mismanagement in the past, where the company found itself issuing convertible debt in down markets to stay afloat (over and over again). The most recent round carried an interest rate of 7.5 percent, but Micron should have the debt paid back shortly (they had $398 million in debt at the end of the quarter, vs. $859 million the prior quarter). As of the time of writing this, the debt is likely all gone. As a result of the debt going away and cash going up, book value has steadily risen. Therefore, the downside is limited.

3. The rating agencies aren't alone in seeing the improved situation at Micron. David Tepper, distressed debt/equity specialist and one of the world's richest men, has Micron as his largest holding. I think he's a smart guy and sees everything I'm seeing in Micron and more. BMO recently upgraded Micron for many of the same reasons.

4. In an efficient market, stocks shouldn't trade below book value unless the company loses money, is forced to dilute shareholders, or there is a lack of a catalyst to unlock the value. Micron's shares have traded under book value in the past due to all three of these reasons. Micron isn't likely to lose money, and the ongoing and significant share buyback provides a catalyst to unlock the value of the stock should it trade down to $30. The way I see it, there isn't a hard floor at $30, but it's tough to see the stock trading much below book value given that the cash-rich management is a big buyer of the stock and the company is making money.

5. Micron is profitable. Earnings estimates are more in line with reality now after the shortage. Current earnings estimates are as follows.

Current analyst estimates have Micron earning $7.88 this year. I think estimates are still a little too high, but even if Micron only earns $6 this year, the floor for Micron's stock ascends to $36. Given that it's trading for less than that now, you're getting a pretty good price. Once the cycle turns, Micron's price to earnings ratio should start to rise again.

Catalysts

  1. The second half of the year traditionally sees stronger demand for semiconductors than the first half. CEO Sanjay Mehrotra indicated in the last quarterly conference call that he expects the excess capacity to work its way through the system by then. The semi markets have become more of an oligopoly over time, so supply should be reasonably constrained compared to past cycles.
  2. Long term, demand for Micron products will increase due to long-term trends like cloud computing, data centers, and the need for semiconductors in cars. The only real question is when the long-term trend will overwhelm the short-term weakness.
  3. The largest current positive catalyst in the stock is the buyback. Micron has been able to use their new debt-free status and pristine balance sheet to finance a massive buyback program of the stock (Micron announced a $10 billion buyback in May). So far, according to their balance sheet, they've bought back roughly 2.4 billion in stock since May.
  4. Another potential catalyst is an end to the trade war. Micron is enormously profitable and their intellectual property portfolio (or at least the tax revenue from it) enjoys the full support of the U.S. government. A resolution to the trade war is likely to include some Chinese concessions around the ongoing espionage and IP theft of U.S. technology companies. Tariff reductions could additionally serve to pad Micron's gross margins and boost EPS.

Risks

  1. Apple's (NASDAQ:AAPL) sales should (honestly) be fine, but if iPhone demand falls below expectations, Micron will be adversely affected.
  2. The flip side to the trade war ending being a positive catalyst is that if the trade war with China escalates, Micron will feel it, both on their top and bottom lines. I feel that this risk, in particular, is adequately priced in.
  3. Micron may not be able to keep up technologically in the future with their competitors, mainly Samsung (OTC:SSNLF) and SK Hynix (OTC:HXSCF) (OTC:HXSCL).

Price Target/Conclusion

I'm not sure if the cycle will turn this quarter, next quarter, or 2-3 quarters from now, but Micron's stock has been priced in the basement since November. This limits your downside. Micron has been aggressively buying back stock and could buy as much as 20-25 percent of total outstanding shares back over the next 12-18 months. When profits eventually pick up, Micron will benefit from both an expansion in profits, and from a greatly reduced share count.

Based on this, Micron could trade up to $75-80 when the cycle turns up again. This may be 12-18 months from now, but the stock will tend to start rallying well in advance of the future strong earnings reports. In light of all of these things, Micron is my top pick of 2019, and the shares are a strong buy.

I'm planning on picking up some call options when the marketwide implied volatility (VIX) gets down to 16-17 percent.

Good luck to all!

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