Just as sentiment surrounding Micron Technology (Nasdaq: MU) was beginning to improve, the company issued guidance that seemed to put the brakes on the chances of a timely recovery. The company’s results were better than expected – but the disappointing outlook prompted the market to dump the stock, which was more than 11% lower by the end of the week.
Micron is a stock a lot of investors have been betting on in the hopes of a recovery in the semiconductor space, and specifically in the market for memory. The fact that it was trading on a mid-single-digit multiple earlier in the year created the impression that the downside was limited. But, is it, in fact, a value trap?
Outlook Points to Slow Recovery
While the results were better than expected, they were a reminder of how weak memory sales have been over the last 18 months.
Fourth-quarter revenue of $4.87 billion was $310 million ahead of forecasts, but 42% lower than a year ago. GAAP EPS at $0.49 was $0.8 ahead of estimates, but a massive 86% lower than a year ago. For reference, in March last year revenue was growing at 58% and earnings were 246% higher than the previous year.
In the current quarter, Micron expects to earn a revenue of around $5 billion and GAAP EPS of about $0.42. While the revenue estimate was higher than expected EPS, the forecast is well below estimates.
Judging by the market’s reaction, investors were probably hoping for guidance to be revised higher.
The earnings forecast points to another ~85% year-on-year decline and further deterioration in the margin. The company also indicated that its inventory levels will result in sales growth lagging market demand for some products. This implies that margins may remain under pressure for some time.
How Much is Micron Worth?
The volatility in Micron’s earnings highlights the danger of using earnings multiples to value cyclical stocks. The forward multiple may appear low at around 8, but if earnings forecasts are revised lower, it will rise very quickly.
In this case, the price-to-book ratio may be more appropriate. In December last year, Micron was trading at its book value before it recovered. However, MU’s price to book has been lower in the past; 0.76 in 2016 and 0.6 in 2011. The book value is currently $32.50 a share. This suggests in an extreme scenario the share could trade as low as $20.
Sentiment May Be Too Bullish
A gradual recovery is still the most likely outcome for Micron’s earnings, in which case the stock may drift down to the trend line at $36, but not much lower. However, the stock is not well-positioned if there is more bad news – something that is not out of the question.
Sell-side analysts are overwhelmingly bullish on the stock. 19 analysts have a buy or outperform rating on the stock, while 11 rate it a hold, and just 4 analysts have a sell rating. This bullish sentiment combined with further bad news would lead to a prolonged selloff.
As it stands, Micron is not necessarily a value trap. However, it will be very vulnerable in the event a further escalation of the trade war, a recession, or a permanent ban on doing business with Huawei.