Micron: Bullish, Easier Money With Pricing Now Up

Micron (Nasdaq:MU) reported EPS that were inline and guided to EPS a touch below the Street. They had positive commentary that demand trends were strong, supply growth was weak and pricing was moving up. Pricing moving up, that's all that matters.

Pricing Moving Up

Here's what they said on NAND:

"...we saw pricing improvements in NAND."

Here's what they said on DRAM:

"We are encouraged by recent DRAM pricing trends and are optimistic about improving supply demand balance throughout calendar 2020."

"During the quarter, DRAM price declines decelerated from recent quarters..."

67% of revenues were DRAM last quarter, 33% NAND (Page 13).

Memory is a commodity business. You don't hear about supply and demand much in tech as you do constantly in memory. Yes the market has consolidated and is more profitable than past cycles. But that does not remove the fact that it's still highly cyclical because it's a commodity business.

Therefore the main gauge of the industry's health, as in any commodity, cyclical is pricing itself. Think oil. Think gold. Think grains. If pricing is moving up it's the clearest message that the supply/demand picture is in balance or improving.

Micron saying NAND prices are moving up and DRAM prices declining less is the major piece of news that can give us conviction that earnings are about to turn around.

We posted earlier this month that Lam Research (Nasdaq:LRCX) said NAND prices started to move up. We've heard it from our other industry contacts. After posting that article and doing more work we added Micron and one other memory play to our model portfolio (paywall).

So Micron is talking about NAND moving up and DRAM bottoming. But that's based on their contracts.

It's actually better than that.

DRAM in the spot market has literally started to move up which to me is so important. It's better than Micron said on their earnings call.

Here's DRAM prices moving up:

Source

So while Micron mentioned on their call that DRAM price declines were lessening, actually in the spot market DRAM prices are jumping.

I have to believe that those spot prices will filter into contract prices. That's starting to add to what drives my earnings model and I'm starting to have stock price upside based on that.

I base my work on earnings. The main driver to revenues and gross margins and thus earnings for Micron is pricing.

Now with both NAND and DRAM prices moving up, this story for me gets much easier. I believe the easier money is now while pricing is moving up.

Here's what I'm using.

Source: Elazar Advisors Models with data pulled from Micron earnings reports.

Above you have volume (bit growth) and pricing (ASPs) trends.

If anything I may be conservative because when things are good pricing can sometimes start moving up double digits sequentially (next quarter versus the most recent reported quarter, not year-over-year).

So my revenue numbers start moving up as well as my gross margins (see full model here: Paywall).

The extra revenues help drive gross margins higher too. You heard the company say the February quarter will be the gross margin low. That tells you they are expecting pricing to move up.

That's important too because they never give pricing guidance, so when they say they expect gross margins to start moving up they are giving you implied pricing guidance.

Gross Margins

Here's what they said on gross margins.

"However, we are encouraged by recent market trends and expect that FQ2 will be the bottom of our gross margins, as pricing increasing, mix of high-value solutions, and cost reductions drive better gross margins throughout the rest of fiscal and calendar 2020. We expect a gradual recovery to start in FQ3, and to continue into the seasonally stronger second half of calendar year."

That "pricing increasing" was the most important little two words that mattered on that entire earnings call.

I think their bullishness on gross margins is because they are getting exciting about some of the NAND and DRAM pricing trends mentioned above.

This is what you want out of a commodity cyclical company - pricing.

Do you want to own oil companies if oil prices are dropping? That's no fun. It's much more fun to own them when oil prices are moving up, right? Well that's what's going on here for Micron.

The other input for gross margins other than revenues is cost of goods sold.

Cost of goods sold moves up because of supply growth and per unit costs. They're slowing supply growth but they still need pricing to offset their cost of goods sold increases. Here's that.

Source: Elazar Advisors Models with data pulled from Micron earnings reports.

Here you see cost of goods sold growth accelerating year-over-year. But now with pricing moving up that should more than offset it, allowing EPS to start moving up again allowing profits to flow through.

Why Pricing Is Moving Up

On the DRAM side you still have a lot of demand for datacenters, servers, PCs, etc. It's amazing the economy didn't tumble through this trade war. Business trends held up just fine. Now with a trade truce you can envision trends improving further. Many companies cleared out inventories worried about worst case scenarios of a trade war.

So customers are sitting generally with lighter inventories. Some China companies do have more inventories but generally you see Micron's inventory position ease.

Source: Elazar Advisors Models with data pulled from Micron earnings reports.

When you see Micron's inventory growth slow it means they are selling through. That avoids a big inventory jam problem.

Cloud customers are starting to reaccelerate capex again. That drives demand.

Here's cloud capex spending, which is so critical.

Source: Elazar Advisors Models with data pulled company earnings reports.

The major cloud players grew a ton last year but piled up a lot of inventory. They had enough inventory, then on top of that they slowed capex early this year. They then had to work through their own high inventory levels.

Now you see expectations are for cloud capex growth to start picking up again.

That helps sequential demand. Here's what Micron said about cloud capex on their earnings and why this number just above is so key.

"Cloud CapEx as you have seen the reports from various major cloud providers, cloud CapEx continues to be healthy, a meaningful portion of the cloud CapEx goes into memory and storage, and that continues to drive above average industry - above average demand as a percentage, which is the average of the total DRAM industry."

A big driver for NAND is mobile. Now with 5G, mobile should drive demand for NAND. So you have pricing already starting to move up ahead of 5G. With a big 5G demand push from March 2020 to year end I think there's a good shot NAND pricing gets even better.

Here's what Micron said on that,

"So certainly 5G will be a growth driver. We expect 5G handset smartphones to be more weighted toward the second half of the calendar year."

Micron's calling for a pickup in 5G second half demand and expecting 5G "will become more important in 2021 as 5G adoption accelerates."

Timing

The stock was pretty much straight up into this earnings report. I'd love to see it go sideways a little bit or down before getting big. But this is one to be looking at to add or get bigger at the right spots.

Conclusion

My EPS numbers are starting to move up now which gives me conviction that we have visibility the stock price can move higher. Pricing is the key driver to commodity stocks in all industries. Here you see real-time NAND pricing turning up in the November quarter and DRAM pricing turning up here in December. 5G and cloud demand should continue to drive pricing and thus Micron earnings and stock price.