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Micron: The Bottom Is Rounding – Micron Technology, Inc. (NASDAQ: MU)



Many were shocked when they heard the guidance for FQ3 issued by Micron's (MU) management and watched the stock take off (positively) in after-hours trading last Wednesday. Revenue $ 4.8 Analysts Difference B $ 5.29B -9.3% EPS $ 0.85 $ 1.20 -29%

jumped. Some of my fellow contributors also felt the negative direction meant doom and gloom for Micron for the rest of the year. However, just making a number comparison does not bring about the medium-term expectations for the memory industry, nor does it tell us what Micron is expecting in the second half of this calendar year ̵

1; beyond what the current quarter suggests

Second Half Recovery Still On Track

Some commenters on several Seeking Alpha news stories and articles repeatedly mentioned management's saying of "low visibility." However, this low visibility does not mean the company does not have an idea of ​​what its customers are doing or planning to do. Considering large memory orders are negotiated ahead of time, and even before that point is in talks with customers about their needs, it's not hard to consider Micron's visibility out at least three months from now

Now, what exactly is management expecting in three months? In the prepared remarks CEO Sanjay Mehrotra gave this color:

… as we talked about our last earnings call, we still expect DRAM bit shipments to begin growing in our fiscal Q3, with demand growth strengthening in the second half of the calendar 2019 and most customer inventories are likely to normalize by mid-year.

Further into the call, an analyst asked about how management had confidence in the second half of the year and more specifically in the FQ3 pickup of DRAM shipments and management responded with:

If the consumption of DRAM by our customers in the end markets, especially the cloud market continues to be healthy, it's just that those customers are using up their inventory to meet that demand. And over the next few months, by mid this year, that inventory will return to normalized levels to a large extent, and then that will provide opportunities for greater demand in the second half of the year compared to the first half .

Considering this downturn was due to increased inventories at customers, a return to normalized levels by mid-year would mean a return to demand from these same customers – which is precisely what management expects

Even if trade worries continue into the spring, customers are still going to have to pull on their still elevated inventories. Once the inventories are normalized – as Mehrotra put it – the pull from the semiconductor companies will resume

What about Inventory And Idling Wafers

Moving to the second part of Micron's initiatives which includes carrying higher inventory levels as well as idling 5% of both DRAM and NAND wafer starts, analysts were confused about how to marry the second half expectations with the execution of lowering shipments. But if one were to step back for a minute, they would realize this makes sense.

Considering the inventory builds are typical of the downturns of the industry combined with the fact that only three major players remain this time around, it's not incomprehensible to see 150 days of inventory expected. Of course, this is the highest one that has been in any downturn, but just a year ago many bears have argued that the oligopoly means little and it will not make a difference. Instead, this is why the oligopoly would rather carry inventory then sell into low pricing in order to gain market share. Moreover, why would any of the major three decide now, this far into the process, to clobber the market they are working hard not to let the bottom drop out of? It is not a logical premise to a thesis

But how does one reconcile 5% idling of wafers? Surely if Micron was expecting a second-half recovery, it would be ramping up and getting ready to sell it all in recovery to return to the sequential revenue and earnings growth. Again, stop and think about where the industry is today compared to where it was two or three years ago. With only three players in this downturn, this is a never before occurring situation. Meaning, Micron will play a part in helping create this second half of the year's recovery.

If the supply was not moderated along with expectations for demand, would not continue on track and would continue to be pushed further out. Perhaps, even, it would not happen at all, as the rise in demand in the second half of the year would be met with supply targeted for a demand expectation of six months ago.

Marrying The Narrative With Guidance

The reason the market has not been punished (down 2% since earnings do not fit the definition of punished Micron is mainly due to the numbers showing relative strength at what seems to be the bottom of the downside. FQ3 guidance is what the previous cycle tops were at their best. Margins, revenue, net income are all above or above the highs

But how do we know this is the bottom, apart from managing telling us a better year is ahead? What market is looking at is the rounding of the bottom;

(Source: Micron's earnings reports, FQ3 guidance and author's FQ4 estimate)

The above chart shows the earnings growth over the last three quarters, plus guidance for the current quarter plus my estimate of $ 0.60 in FQ4 EPS. Note how the deceleration of earnings has begun to shift in the last quarter and the guidance has created a rounding of the bottom. Even with a gradual decline in earnings for FQ4, the growth rate continues to move back to 0%, heading for a return to growth.

The above chart shows the correlation between the last cycle's low in 2016 in the rise in 2017. The inflection in FQ2 2016 and FQ3 2016 is the same point we are seeing going into the second half of Micron's fiscal year now. It is obvious that the market will track down the downward trend in terms of quarter-to-quarter deceleration and re-acceleration of growth

This is why the company can issue downside guidance and still have the market to respond well – it's in the expectations of negative growth slowing. Therefore, it is not incomprehensible that the market can see the expectations for a better second half, the idling of wafers, and the slowing of negative earnings as Micron tagging the bottom and heading higher fundamentally

Conclusion

Overall, the company aligned it is not a backing up with inventory adjustments, lowering supply, and matching capex for the expected demand. The company is talking the talk and walking the walk. The market not only sees this but also sees earnings beginning a round-out of the bottom and even with a sequentially lower FQ4 expected, the earnings growth has stopped decelerating and is beginning to turnaround.

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Disclosure: I am / we are long I wrote this article myself, and it expresses my own opinions. 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