Micron: Memory and storage development powered by AI and HBM3; Price Out of Bottom (NASDAQ:MU)

micron (NASDAQ:MU) stands out as a major player in the DRAM and NAND industry. Its growth is fueled by growing demand for AI and its upcoming HBM3 products. The company expects a turnaround in 2024, setting the stage. For full growth momentum by 2025. With the current stock price down, I recommend initiating coverage with a ‘Buy’ rating, assigning a fair value of $96 per share.

Growth through data center and AI workloads

The data center stands as a key growth driver for Micron, with demand for DRAM for data centers expected to grow by 28% and NAND by 33%. Several factors contribute to this growth expansion. First, Micron anticipates that AI servers will demand significantly more memory, with 6x to 8x DRAM content and 2x to 3x more NAND content. Considering the early stage of AI adoption, this This indicates substantial growth potential for Micron’s DRAM and NAND business in the future.

Secondly, in addition to the growing demand for AI-related workflows, Micron’s HBM3 memory products are emerging as the frontrunners among their competitors. According to their recent conference, Micron’s HBM3 performs 10% to 15% better than any other competing product, along with more than 25% better power functionality than its peers. The HBM3 proves to be a key memory product for AI workflows, and its superior features position Micron to gain market share in the AI-related market. They project that their market share for HBM3 will match their DRAM industry share by 2025.

Finally, the entire IT industry is witnessing an increase in demand for data analytics, including both structured and unstructured data sets. This growing demand for data analytics requires substantial data storage, thus driving the development of memory products. In summary, Micron is poised to experience both industry growth and market share in the era of AI computing.

2024 for rehabilitation and 2025 for development

As shown in the table below, Micron exhibited significant growth in FY21 and FY22. However, the company suffered a significant setback in FY23, with revenues falling by 49.5%. The slowdown is due to slower demand in computing and networking, mobile devices and embedded memories. Consequently, due to operating leverage, operating margin declined, recording a reported figure of -37%.

Micron’s management predicts an industry recovery in 2024, with full growth expected by 2025. In the long term, they expect mid-to-high single-digit growth in DRAM and low-teens growth in NAND. Several pieces of evidence support their optimistic view.

According to their findings, inventory levels for memory and storage across industries including PC, mobile, auto, industrial, and data center are at normal levels for most customers. This suggests a positive sign for Micron’s future growth and points to a return to normalcy in the industry after the pandemic.

Additionally, during its earnings call, Micron indicated expected mid-single-digit growth in total server unit shipments within the data center market in 2024. This growth contrasts with the low double-digit decline seen in 2023, indicating a positive shift in the market.

Additionally, Micron is set to begin a volume production ramp-up for its HBM3E as early as calendar year 2024. They expect HBM3E to generate several hundred million dollars in revenue in FY24. With production ramping up, substantial growth of their HBM3E product in FY25 is a reasonable expectation.

Recent results and FY24 outlook

They reported the first quarter of FY24 on December 20, 2023, and Micron posted an impressive 15.7% revenue growth, marking a positive turn in its financial performance. Notably, free cash flow also showed improvement, declining from -$1.5 billion in Q1 FY23 to -$333 million in Q1 FY24.

At the end of the quarter, Micron had $9.84 billion in cash and cash equivalents, tied with $13.5 billion in debt. Despite the debt burden, the company maintains relatively low net debt leverage, reducing a flexible balance sheet and confirming its financial stability.

Micron’s recent quarterly results vindicate their view of an industry recovery in 2024. Additionally, their Q2 FY24 guidance suggests an impressive 46% year-on-year revenue growth. In particular, Micron emphasized that price increases are a key contributor to their full-year guidance, which reflects expectations for continued price increases throughout the year.

Micron looks set to exhibit more top-line growth in the coming years, driven primarily by AI adoption and HBM3. Their estimates indicate a strong growth trajectory for HBM3 with an expected 50% CAGR over the next few years. Similarly, data center AI accelerators are expected to grow at a whopping 70% during the same period. This industry demands position Micron for significant revenue growth.

Additionally, the expected price hike is set to significantly improve their gross margins, further contributing to the positive outlook for the company.

Kioxia stands out as one of Micron’s primary competitors. According to Kioxia’s Q2 FY23 results, there is a positive trend in the supply-demand balance, with selling prices reaching a bottom. The improvement was attributed to production adjustments made by flash memory manufacturers, impact on aggregate supply, and normalization of customer inventories. Kioxia’s market outlook is in line with an expected recovery in 2024, and they expect prices to continue to rise throughout the year.

Value

The model indicates a recovery year in FY24, projecting top-line growth of 25 percent. Factoring in the price bottom out and related operating leverage, the estimated operating margin is expected to reach 22.1% in FY24. For normalized revenue growth, the company’s guidance suggests high-single-digit growth, with the model assuming a conservative 8%. Historically, the memory market has outpaced the overall semiconductor industry in growth. Additionally, the substantial growth opportunities through AI and HBM3 suggest that the 8% revenue growth assumption can be considered conservative.

The model uses factors of 10% discount rate, 4% terminal growth and 10% tax rate. Based on these parameters, the estimated fair value is $96 per share.

Key risks

China restrictions: Mainland China contributed 14% of the group’s revenue in FY23. In May 2023, China’s Cyberspace Administration decided to bar key information infrastructure operators in the country from purchasing Micron products. The move appears to coincide with rising geopolitical tensions between the US and China, prompting the Chinese government to take precautionary measures.

High CAPEX expenses: Due to efforts to expand their manufacturing capacity, capital expenditure was around 50% of total revenue in FY23. The company aims to gradually reduce that figure, targeting mid-30s percentage points for capex spending over time. Substantial capex expenses are associated with their business model and are expected to continue to impact their free cash flow margins.

Decision

I believe Micron will continue to gain market share in AI computing. With the stock currently undervalued, I initiate coverage with a ‘Buy’ rating and a fair value estimate of $96 per share.