$MU Fiscal Q3 Earnings Preview

by Enis June 20, 2014 12:09 pm • Commentary

Event: MU reports its fiscal Q3 earnings on Monday after the close. The options market is implying about a 7.5% one day move, which is in line with the four-quarter average of about 7.75% and the eight-quarter average of about 7.25%.

Sentiment: Wall Street analysts are somewhat positive on the stock, with 22 Buys, 7 Holds and 4 Sells, and an average 12-month price target around $36.50.  MU is already up 45% year-to-date, and has increased fivefold since the end of 2012.  Despite that impressive rise, short interest in MU remains at 10% of the float (though a portion of that short interest is hedges against convertible bonds).

Options Open Interest: Open interest is skewed towards calls over puts by a ratio of 1.45 to 1. Call have been much more active over the past month, with the one month average near 2 to 1. The following strikes within 10 bucks of current spot have over 30k in open interest (not including today’s expiration):

-Jul19th 24 calls, Jul19th 25 calls, and Jul19th 29 calls

-Jan15 22 puts, Jan15 25 puts, Jan15 25 calls, Jan15 30 calls, and Jan15 35 calls

Given MU’s run, not much open interest lies above the $35 level, while the bulk of open interest is between $20 and $30.

Price Action/Technicals:   MU is trading at its highest level since 2002, after quite a run over the past 1.5 years.  In that period, the stock has hardly traded below its 50 day moving average, let alone touched its 200 day moving average:

MU daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg
MU daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg

The only real resistance on the upside is the $40 high from 2002.  The stock is trading at its highest level since then, and remains in a steady uptrend.  The rising 50 day moving average is now around $27.25, while the 200 day moving average is now around $22.50.

Fundamentals:  Micron has been a major beneficiary of improved DRAM (dynamic random access memory) chip pricing in the past couple of years.  Bulls have been correct in noting that there are fewer DRAM suppliers in the past combined with more products that require the chips.  While PCs have traditionally been the major consumer of DRAM chips, MU (and the DRAM market) have expanded quite quickly in mobile and server computing as well.  From Micron’s February investor presentation:

Screen Shot 2014-06-20 at 12.00.05 PM

So the DRAM market backdrop has been favorable, and Micron has benefitted.  At this juncture, the question to ask is how much is in the price?

GS Research noted that despite the solid pricing environment of the past year, new entrants might result in lower pricing going forward:

We remain Neutral rated. We expect the stock to trade at a higher multiple while supply/demand remains tight. However, we remain concerned about the sustainability of the cycle as DRAM EBIT margins are already in the high 20%/low 30% range, and this may attract new supply. This could come from memory companies shifting capacity from NAND (we believe Hynix is losing money in NAND but has low 30% DRAM margins), or from other sources (such as foundries or Tier 2 DRAM makers with much lower margins). Key risks to our view relate to sales and margins.

Bulls are more confident about MU’s place as a premier supplier in the market.

In any case, valuation certainly looks reasonable, even using EV/EBITDA, which is on the high end of the 10 year range, but low on an absolute basis at around 6.5x:

MU Enterprise Value / EBITDA ratio, Courtesy of Bloomberg
MU Enterprise Value / EBITDA ratio, Courtesy of Bloomberg

In sum, MU is an execution story.  The stock still looks cheap if the high earnings expectations going forward are met.

Volatility:  Even with the high upside volatility in MU (the stock rallied 50% from its mid-April low to its mid-June high), implied volatility in MU has remained relatively low since daily close-to-close volatility has not been high:

30 day implied volatility in MU, Courtesy of Bloomberg
30 day implied volatility in MU, Courtesy of Bloomberg

Even with the earnings event, MU implied vol is lower than it has been for much of the past year.  Having said that, the broader market backdrop remains a low volatility environment, which could send MU implied vol back down to around 35 after the event.

Our View:  Micron has been one of the best performing technology stocks of the past 18 months, and that’s quite a statement.  Skeptics maintain that Micron’s business remains prone to excessive competition and pricing pressure when margins remain attractive like they have been in the recent past, while bulls point to the changed competitive dynamics and favorable product diversification at Micron.

Technically, the stock’s still in a clear uptrend and innocent until proven guilty.  We don’t plan to trade this name ahead of earnings since the implied move looks reasonably priced and we don’t have an edge on the fundamentals, but our one takeaway would be that options look priced on the low end of what we would expect given the stock’s move over the past couple of years.