The past year has been a rough one for Micron (NASDAQ: MU) stock investors. Shares of Micron stock are down 45% from a year ago, but long-term investors should be considering buying the dip.
The memory market has been weak, and Micron has certainly suffered. However, there are at least three reasons why the worst has now passed for MU stock, according to Bank of America analyst Simon Woo.
MU Stock Is Fairly Valued
Despite ongoing weakness in the memory market, Micron’s big sell-off has the stock valued attractively. In fact, the stock has recently traded at or below projected book values for fiscal 2019 through fiscal 2021. The stock’s PE ratio of 3.0, its forward PE ratio of 7.8 and its price-to-free cash flow ratio of 4.7 are all absurdly low.
Sure, given the market weakness one could argue these valuation metrics deserve to be low. After all, revenue and net income were down 20.6% and 51.0% last quarter, respectively. However, assuming you believe the pricing weakness in the NAND and DRAM markets will eventually recover, Micron stock has no business at its current valuation.
Many of the stocks trading at single-digit earnings multiples are facing secular, not cyclical headwinds. Companies like Macy’s (NYSE: M), Kroger (NYSE: KR) and HP (NYSE: HP) arguably deserve their low single-digit earnings multiples. Micron does not.
2. Micron Is Still Profitable
Despite a cyclical downturn in the memory market, a softening global economy and a trade war between the U.S. and China, Micron is still profitable. It’s a perfect storm for Micron bears at the moment. Yet the company reported $1.42 in EPS last quarter.
Maybe it will take a quarter or two for the market to stabilize and for Micron’s business to return to growth. In the meantime, how much more downside can traders expect out of a stock that has relatively strong underlying fundamentals?
China accounts for roughly half of Micron’s sales, and the recently blacklisted Huawei accounts for 13%. Bank of America is projecting a 20% quarter-over-quarter decline in DRAM prices in the fiscal fourth quarter. Yet even though everything is going wrong for Micron, Woo says the company will likely maintain operating margins above 20%.
Fiscal 2019 through 2021 EPS will be in the $3 to $5 range, according to Woo. Even assuming the $3 low end of that estimate range, it still means the stock is trading at a forward PE of under 11. Maybe there’s not tremendous upside if Micron’s numbers disappoint. But it’s very difficult to see much wiggle room to the downside from current levels.
3. Expectations Are Extremely Low
One of the reasons why it will take a lot for Micron to trigger additional selling volume is because expectations are already so low. Woo says Micron will likely report a modest earnings miss later this month. However, the stock is already down 12.4% in the past month and 15.7% in the past three.
Woo says even a guidance cut from Micron management might not move the stock.
“A bearish guidance at the 3Q FY19 results call and consequent consensus estimate cuts should not be a surprise for investors,” Woo said.
In addition, minimal debt, positive free cash flow and disciplined capital spending provide plenty of cushion for Micron’s business. The company has the financial flexibility to weather the storm.
“We do not expect consensus estimate cuts or bearish guidance (for Nov’19-end quarter) to be a negative surprise, given investors’ low expectations,” Woo sais.
Finally, potential bullish catalysts, such as a trade war deal, are certainly not priced into MU stock. In fact, Woo says DRAM pricing should stabilize and begin to rise again throughout fiscal 2020. He estimates Micron will return to earnings growth beginning in the fiscal first quarter.
Bottom Line on Micron Stock
Yes, things have been bad for Micron. Yes, the memory market is still very weak. But semiconductor investors know the industry is prone to cyclical downturns. The current downturn has been rough for Micron. However, all things considered, its business has held up relatively well.
Secular demand for memory hardware isn’t going away anytime soon. Micron’s market will improve, and investors will once again appreciate the stock’s value. Traders who buy now may be getting in a bit early. But with valuation providing a near-term floor, the risk-reward balance is firmly skewed to the upside.
Bank of America has a “buy” rating and $43 price target for MU stock.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.
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