Gurus Back Micron Amidst the Revival of the Semiconductor Industry

The semiconductor industry is cyclical, and picking companies to invest in can turn out to be a tricky task. The uncertainty surrounding the sector often leads to the mispricing of securities, which provides great investment opportunities. For example, I published an article on Skyworks Solutions (SWKS) on Sept. 20, 2019, when shares were trading at around $81, in which I assigned a target price of $109. Shares closed at $124.17 on Jan. 17, 2020, gaining 53% in this short time.


Along with the improving outlook for the industry as a whole, many other leading names are turning out to be attractive investment opportunities. Micron Technology, Inc. (NASDAQ:MU) seems significantly undervalued and looks poised to provide stellar returns to investors in 2020.

Why the industry is cyclical

Semiconductor company revenue, at times, keeps growing for several years based on the demand and supply of chips but eventually turns negative and remains so for a few years. Understanding this phenomenon is key to making well-informed investment decisions in this sector.

Source: Statista, "Global semiconductor industry revenue growth"

According to data from Regions Asset Management, there are two factors behind this cyclicality.

  1. The level of inventory
  2. Global economic growth



The impact of the second factor is relatively easy to understand by analyzing the above chart, as it depicts the negative growth in revenue during the financial crisis of 2008. Inventory buildup, on the other hand, occurs as a result of demand and supply dynamics. When supply overtakes demand, inventory build-ups become common, leading to falling chip prices and eventually declining profitability.

The current stage of the cycle

Global semiconductor sales fell by approximately 13% in 2019. Last June, SEMI, the global industry association representing the electronics manufacturing supply chain, projected that sales would drop around 11%. In 2020, SEMI expects the market to gain some momentum based on the improving demand for chips resulting from the rollout of the 5G technology, and the trend is expected to continue in 2021 as well.

Source: SEMI, "Semiconductor industry revenue by country"

Len Jelinek, senior director at IHS Markit, wrote:


"Throughout the history of the semiconductor industry, every market downturn has ended with the arrival of a technological innovation that spurred a major increase in demand. In the past, these innovations have had momentous impacts, such as the advent of the world wide web or the introduction of the iPhone. Now another historic innovation is set to take its place among these advances: 5G."



The downfall of the industry triggered as a result of the fall in dynamic random-access memory (DRAM) and flash memory prices in the latter half of 2018, and Jelinek expects this to reverse in the second half of this year as the demand picks up.

Sanjay Mehrotra, the CEO of Micron, believes that 2020 will be the turnaround year for the company and the industry as well. "We are optimistic that Micron's fiscal second-quarter will be the cyclical bottom of our financial performance," he said in a statement.

These industry dynamics paint a positive picture for chipmakers in general, so investing in semiconductor companies with strong balance sheets and attractive growth prospects could lead to double-digit gains for investors this year.

The launch of the X100

In October last year, Micron launched its first 3D Xpoint product; the X100. This is considered as the world's fastest storage device and is expected to drive breakthrough performance improvements for many applications, including the use of Artificial Intelligence (AI) in data centers.

Source: Company website

This could turn out to be an important step in digitizing the world further, and while Micron has made the product available to only a select few customers so far, a mass-market distribution can be expected soon. With the advent of this latest device, the company stands in a much better position than its peers to win new customers that focus on providing advanced data-oriented solutions.

Smartphone sales might pick up in 2020

Mobile memory and storage devices constitute a significant portion of company revenue. For instance, according to company filings, this segment accounted for 29% of total sales in the first fiscal quarter of 2020 ended in last November. The CEO confirmed this view in the first-quarter earnings call:


"We are confident that 5G will be positive for both memory and storage content growth, as well as smartphone unit sales, and are encouraged to see the launch of affordable 5G phones with price points as low as $300 that feature a minimum of 6 gigabyte of DRAM. The 5G phones launched to date average 8 gigabyte of DRAM and 200 gigabyte of NAND, significantly higher than the average content in smartphones today."



Smartphone shipments have been falling on a global scale in the last few years, as exhibited in the below chart. This has been one of the primary reasons behind the negative expectations for chip-makers.

Source: Statista

A revival in mobile handset sales is expected by the research firm IDC as well. In a report issued last September, IDC noted that many consumers in developed regions of the world and in China will likely shift to 5G-enabled Smartphones, leading to higher sales.

Source: IDC

Although industry-wide sales might not grow at attractive rates, the penetration of new generation devices will lead to higher unit sales. This should be sufficient for semiconductor companies, including Micron, to grow their mobile segment revenue and earnings for at least another three years.

Micron is undervalued

Micron shares bottomed out last July and have continued to rally since then based on the optimism surrounding the industry outlook for the next five years. Even though the financial performance of the company was disappointing, with both revenue and net income declining in each of the last four quarters on a year-over-year basis, investors remained bullish on the stock. This led to a stellar performance from Micron shares in the last 12 months.

Source: GuruFocus

A few notable analysts have upgraded Micron shares since the beginning of this year, based on expectations for higher industry-wide demand for chips.

  • Mizuho analyst Vijay Rakesh listed Micron as one of his best picks for 2020 (Jan. 16).
  • Cleveland Research upgraded shares from Neutral to Buy and assigned a fair value of $67 (Jan. 14).
  • Cowen analyst Karl Ackerman released a report citing his expectations for fundamentals to improve sooner than expected due to the attractive cost position of Micron relative to its peers. He went on to raise the target price for shares from $50 to $70 (Jan. 7).



According to TipRanks, 25 analysts covering the company assigned a median target price estimate of $64.82 for shares, indicating an upside of 12.4% from the market price of around $57.66 on Jan. 20.

Takeaway

Micron shares are trading at an attractive valuation, and the expected revival of global semiconductor sales in the second half of 2020 will be the catalyst for shares to converge with their intrinsic value. Even though there could be significant volatility until the company reports positive financial performance, investing early in this idea could yield the best returns for investors.

Many gurus, including Seth Klarman (Trades, Portfolio), Charles Brandes (Trades, Portfolio), David Einhorn (Trades, Portfolio) and David Tepper (Trades, Portfolio) are bullish on company prospects and hold long positions in shares, according to data from GuruFocus. This is another indication of what investors can expect from Micron in the coming years.

Disclosure: I do not own any stocks mentioned in this article.

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This article first appeared on GuruFocus.