Micron Technology Earnings: Long-Term Bullish (NASDAQ:MU)

Micron Technology (NASDAQ:MU) just released its fiscal second quarter earnings. The company reported $7.78 billion in revenue (up 25%) and $2.14 in adjusted EPS (up 277%) for the period. The release beat analyst estimates. Both revenue and EPS were well ahead of what analysts expected. The Q3 guidance was also above what analysts expected. Micron said it expected $8.7 billion in revenue and $2.46 per share in earnings for the next quarter. The expected figures were $8.2 billion and $2.24, respectively.

So, it was a great quarter. Not only was the growth strong, but the company beat analysts' already high expectations. Micron showed that it was able to put out strong numbers even with the Russia/Ukraine war and Apple's (AAPL) production cut in the picture. Both of these developments were seen as headwinds for Micron, whose stock sank in the weeks prior to the release.

MU's growth has been phenomenal for the past few quarters, but until recently, many weren't convinced it would last. RAM prices are extremely volatile, and a company like Micron can get smacked down when prices fall. It's a real risk. But as Q2 showed, it wasn't enough to stop Micron's heady growth in sales, earnings and cash flows.

Micron's second quarter coincided with a difficult time for the world. In the period, a war broke out between Russia and Ukraine, inflation surged, and Apple cut iPhone production by 20%. At least two of these factors could have impacted Micron's revenue in the second quarter. MU stock began sinking after the company announced it was complying with the sanctions on Russia; its price remained relatively low (below $80) when Apple's production announcement was made. The selloff on Russia/Ukraine concerns appears to have been excessive, as Micron's clients are overwhelmingly American. The Apple news came too late in the quarter to have a measurable impact.

In light of what we've seen, Micron's rosy guidance appears justified. The war isn't hitting the company too hard, and Apple's production cut is most likely temporary. Another quarter of triple digit earnings growth is quite possible. Later this year, the company will begin to lap quarters in which this growth had already taken place, so some deceleration may occur. But there are enough growth catalysts on the horizon to justify making Micron a medium term holding. When we consider that along with the fact MU still trades at just 9.5 times earnings, we've got the makings of a solid value play here.

Competitive Landscape

Micron Technology is in the semiconductor industry. It operates in two main verticals within that industry:

DRAM is random access memory, the kind of memory used to access storage for quick use in tasks. NAND flash is long term storage, such as SSDs.

The DRAM industry is not very competitive. There are two main players in the industry apart from Micron: SK Hynix and Samsung (OTC:SSNLF). Micron is in third place after those two by revenue. There are other companies that manufacture DRAM, but none of them have significant market share. So Micron is in third place out of three main players. That might sound like it makes Micron a bit player, but it doesn't. Three players in one industry leaves plenty of room for strong margins for all of them. Micron's $2.44 billion in net income yields a 31.3% net margin on $7.79 billion in revenue. That illustrates perfectly the kind of margins that are possible in the DRAM space.

The NAND Flash business isn't as profitable as the DRAM business, because it has more competition. According to Statista, there are at least six major NAND Flash players globally. That kind of competition tends to put pressure on margins. However, according to Micron's Q2 release, only 25% of revenue comes from long term storage. 73% comes from DRAM. So, Micron's business is well structured for profit maximization.

Earnings Recap

In the second quarter, MU delivered stellar earnings, showing that it was still able to grow even with all the global headwinds that were in the picture. Some of the standout metrics included:

• Revenue: $7.78 billion, up 25%.

• GAAP EPS: $2, up 277%.

• Adjusted EPS: $2.14.

• Operating cash flow (six month period): $7.56 billion.

It was a blockbuster showing, no matter how you put it. The year-over-year earnings growth was the best in a string of three quarters, all of which saw triple digit earnings growth. Earnings declined a little on a sequential basis, but that was likely due to seasonality. The Christmas season is a busy time for smartphone vendors, which make up a big part of Micron's DRAM client base. So, for earnings to be nearly flat sequentially is actually a big win here.

There are many catalysts that could take Micron's earnings higher in the years ahead. A big one would be the lifting of the U.S. embargo on semi exports to China. Currently, it is illegal for companies like Micron to export equipment to China. Previously, MU was doing a lot of business selling to Huawei. If the export embargo were lifted then Micron could get that business back. That would produce a massive one-time pop in earnings, possibly followed by continued growth from there. Huawei was 10% of Micron's business before the export ban came into effect, so getting that business back would in itself would be a huge win, to say nothing of the possibility of getting new Chinese clients.

Risks Heading into Earnings

An earnings beat is a surprise by definition, since "beat" means exceeding expectations. Nevertheless, Micron's second quarter was perhaps more surprising than your average earnings beat. Going into the release, Micron was exposed to numerous perceived risks, which led to its stock briefly going below $70.

The biggest of these was the war between Russia and Ukraine. Shortly after Russia invaded Ukraine, the U.S. announced a sweeping round of sanctions on Russia. The sanctions included U.S. organizations that provided "technological support" to Russia. Shortly after the sanctions were announced, Micron announced that it was complying with them. That may have contributed to a selloff in Micron shares that occurred around the same time.

A second risk factor was a production cut by Apple. In March, Apple announced that it was cutting iPhone SE production by 20%. Apple, one of Micron's biggest clients, uses Micron DRAM extensively in its phones. A cut in phone production could theoretically result in less sales for MU. However, that's not guaranteed. The 20% cut was only for the SE, not the whole iPhone lineup. If sales across the entire lineup are strong in the next quarter, then Micron may still hit its guidance.

A third and final factor was the Covid-19 situation in China. China experienced its worst Covid-19 outbreak since 2020 in the calendar first quarter, which overlaps Micron's fiscal Q2. Shenzhen was locked down early in the quarter, Shanghai was locked down later. The first of these lockdowns resulted in Apple/Foxconn factories being closed, the second permitted factories to remain open as long as they could isolate employees.

All of these factors together dimmed sentiment toward Micron stock in the lead up to its earnings release. In March, Micron dipped as low as $69, as the perceived risk factors began to pile up. The earnings release led to a big rally after hours, though it faded in Wednesday trading.

How Micron Beat Expectations

It's pretty incredible that Micron put out such a strong earnings release in light of all the risk factors it faced. However, it's not that surprising when we consider a few things.

First, Russia was never a big concern for Micron. The company mainly supplies RAM and NAND flash to U.S. clients. It used to supply some Chinese firms, but that business was gone by 2019. There was some possibility an indirect impact via Apple closing its Russian stores, but it would have been small. Russia only accounts for about 2% of the global economy.

Second, Apple's production cut hadn't kicked in by the end of the quarter just reported. It was announced just a few days ago. It could begin to have an effect in the upcoming quarter. However, the cut is only to the iPhone SE, not the whole iPhone lineup. Overall sales could still be strong. Indeed, investors appear to be expecting sales to be strong, as AAPL stock has been doing reasonably well since the production cut was announced.

Finally, the Chinese lockdowns were not as big a deal as they appeared to be. The first lockdown in Shenzhen did shutter factories, but only lasted about a week. The second one allowed factories to remain open provided proper safety measures were followed. Perhaps the lockdowns delivered a small hit to Micron's business, but not enough to prevent a massive beat from materializing.

Profitability and Valuation

Having looked at the risks Micron faces, we can now turn to its profitability and valuation. Previously, I calculated Micron's Q2 profit margin at 31.3%. Now, let me turn to Seeking Alpha Quant to get the trailing 12 month figures.

In the trailing 12 month period, MU's key profitability metrics included:

• EBIT margin: 29%.

• Net margin: 24.5%.

• Return on equity: 17%.

• Free cash flow margin: 4.5%.

Apart from the free cash flow margin, these were all very strong. The lower FCF margin is easy enough to explain. Micron's FCF is lagging earnings because the company is making heavy capital expenditures to grow its business. Operating cash flow is still very strong. As long as Micron's capital expenditures pay off in the future, the depressed FCF is not a bad thing.

Taking into account Micron's strong growth, profitability and competitive position, you would think it would be a mighty expensive stock. But in fact, it isn't. As of Yesterday's earnings release, Micron traded at 9.5 times adjusted earnings, 12.5 times GAAP earnings, 2 times sales, and 5.36 times operating cash flow. All shockingly low multiples. Yet Micron is producing growth far above the tech industry average. It definitely seems like we've got an undervalued situation here.

Of course, RAM is technically a commodity, and a decline in its price could result in an abrupt downswing in Micron's profits. But I wouldn't bank on that happening soon. The global supply chain crisis rages on while big tech companies continue to ramp up their cloud computing investments like their lives depend on it. This should contribute to favorable supply and demand dynamics for at least another year or two. Micron is no "buy and forget" play, but it is incredibly well suited to today's market conditions.

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