Micron Stock Is a Long-Term Winner, But the Near-Term Outlook Is Uncertain
Shares of chip maker Micron (NASDAQ:MU) dropped below $50 for the first time since early May on a price target cut by Wells Fargo analyst and MU bull Aaron Rakers. Rakers cut his price target on MU stock from $70 to $63, citing earnings erosion ahead. But he also maintained his “Outperform” rating on the stock, and said that the earnings erosion is already fully priced into the shares.
I largely agree with Wells Fargo’s take on MU stock.
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This is a company whose golden days are in the rear-view mirror. Micron is expected to generate peak earnings of around $12 per share this year. Subsequently, increased supply in the memory market will dilute Micron’s pricing, and its earnings will drop. But demand from data-intensive end markets will remain robust and offset some of that supply ramp. Thus, Micron’s EPS over the next several years should remain largely above $7.
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In that scenario, MU stock could easily see prices north of $60 and even $70 over the next one to two years. Thus, at $50, MU stock offers attractive return potential over the longer term.
But this is a tough stock to own here and now, as there’s so much uncertainty about its earnings over the next few years. As such, I think this stock is a near-term sell and a long-term buy.
Micron’s Earnings Will Likely Stabilize in Two to Three Years
MU stock has exploded higher over the past several years, thanks to exceptionally favorable supply-demand dynamics in the memory market. Namely, there has been a bunch of demand from data-intensive end markets like artificial intelligence, Internet of Things, and data centers. Meanwhile, the supply of chips has become limited because they have become increasingly complex. Strong demand and small supply caused Micron’s profits to surge.
That golden era is presumably coming to a close soon. Supply is ramping in the memory market, and that change will inevitably reduce Micron’s profits. Investors are freaking out about earnings erosion over the next several years and bailing on MU stock.
But the narrative surrounding MU stock doesn’t end with earnings erosion over the next one to two years. This isn’t the first time supply increases have diluted Micron’s profits. This phenomenon has happened before, and each time, Micron lived to fight another day. Its earnings typically declined for about two years and dropped about $4 per share from peak to bottom.
Assuming history repeats itself (and it should, because demand from data-intensive end-markets isn’t going to ease any time soon), Micron’s earnings power will stabilize around $7 to $8 per share in two to three years.
Long-Term Gain, Near-Term Pain
Assuming Micron’s earnings stabilize around $7.50 in two to three years, then MU stock has upside to the upper $60’s over the next one to two years.
The math here is pretty simple. Due to Micron’s noisy and cyclical earnings, MU stock never gets a big multiple. The average historical multiple for this stock is nine time forward earnings. Placing that historical average multiple on $7.50, you arrive at a one to two year forward price target for MU stock of $67.50.
MU stock won’t reach that level right away. The sentiment surrounding semiconductor and chip stocks isn’t the best right now because of potential tariff exposure and supply ramp issues. Plus, it is hard for a stock to stage a meaningful rally when everyone is worried that the company’s earnings will drop soon. There is a lot of uncertainty about how much Micron’s earnings will erode (just look at how wide analysts’ earnings estimate range is for 2020), and uncertainty is a big negative for stocks. The technicals of MU stock also aren’t that great.
Consequently, I don’t think that MU will really be a big winner here and now. Instead, I actually believe that this stock will be weighed down by uncertainty until the next earnings report provides more clarity into its earnings outlook.
If the company’s results are good and its earnings outlook is strong, then MU could get back to its winning ways and head towards $70. If the report isn’t good, Micron stock will remain weak.
As a result, I think MU stock is too risky right now, but offers an attractive value proposition for long-term investors.
Bottom Line on MU Stock
Long term, MU stock is a winner because of the outlook for persistently strong demand from data-intensive end markets for memory chips. Near term, MU stock could fall further as uncertainty weighs on sentiment and valuation.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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