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Morningstar | The Tide Turns on the Memory Gold Rush as Micron's Guidance Forecasts Dark Clouds in 2019

Micron Technology reported solid fiscal first-quarter results, largely fueled by record mobile-related sales. However, all eyes were on the firm’s guidance as bloated inventories at hyperscale, high-end smartphone, and GPU customers combined with PC chip shortages have created a dreary outlook for the memory space in 2019. For the majority of 2018, we had been anticipating the recent favorable supply/demand dynamics to shift toward oversupply, and industry commentary from the past few weeks has strongly corroborated this sentiment. Management highlighted the precautionary measures Micron is taking to navigate near-term industry headwinds and maintain solid profitability, including lowering DRAM bit output growth from 20% to 15% and NAND bit output growth from 40% to 35%. We think these levels are probably more consistent with industry demand growth.

The firm also expects to build inventory levels instead of flooding the market with product, in order to take advantage of the second-half calendar 2019 recovery that CEO Sanjay Mehrotra has prognosticated. Historically, memory chipmakers haven’t taken such pre-emptive actions this early in the cycle, especially when profitability is still excellent (42% net profit margin during the quarter). We think this validates our overall semiconductor thesis that future cycles will feature less severe peaks and troughs thanks to more rational behavior and better diversified end markets. Micron shares fell 9% during after-hours trading and are now at a discount to our unchanged $40 fair value estimate. Although we now model fiscal 2019 being down considerably, we expect a solid recovery thereafter thanks to the proactive efforts of the key memory participants. Nevertheless, we’d wait for a wider margin of safety to invest, given our very high uncertainty rating for no-moat Micron.

First-quarter revenue grew to $7.9 billion, up 11% sequentially, led by a 17% gain in mobile business unit sales thanks to strength in low-power DRAM offerings and share gains at several leading customers. Despite near-term unit headwinds in the smartphone space, we continue to be optimistic on overall content gains, as flagship devices boast higher storage capacities and more compute for advanced functions such as local artificial intelligence (Face ID on the Apple iPhone), more advanced cameras (Night Sight on Google Pixel), or augmented reality applications. In contrast, compute and networking sales fell 17% sequentially due to excess inventory in the graphics, enterprise, and cloud markets. Storage revenue fell 8% sequentially due to weaker pricing, similar to NAND-centric peers. We note the firm is transitioning from SATA to NVMe solid-state drives, which enable read/write speeds at the level of the NAND flash as opposed to the slower SATA connection. While this transition will allow for a higher-value SSD mix in the future, it will hinder storage sales throughout fiscal 2019.

Gross margins fell 270 basis points from last quarter to 58.3%, partially due to a 120-basis-point impact from 3D XPoint underutilization costs. The firm alleviated the impact of China trade tariffs to less than 50 basis points, while management expects to mitigate 90% of the impact from tariffs starting in January 2019. Fiscal second-quarter sales are expected to be at a midpoint of $6 billion, which implies a sequential decline of 24%. CFO David Zinsner said the firm will reduce its prior capital expenditure guidance from a midpoint of $10.50 billion to $9.25 billion to align with the output targets. We had previously contemplated capex levels below the original guidance, and this update does not materially alter our estimates for the wafer fab equipment space.