Micron (MU) Intrinsic Value - DCF Calculation - Deep Dive

Micron has been a top holding for a lot of big-name value investors over the past year, such as Mohnish Pabrai, Li Lu, and Guy Spier. At the time of this writing the share price was $94.12 with a market capitalization of ~$105 billion USD, which is flat year over year. During the past year its high was $98.45, and its low was $65.67. In this blog post I will be looking at their business, going through all their financials, and doing a DCF (discounted cashflow analysis) to come up with an intrinsic value.

• What is Micron? What does Micron do?
• Revenue
• Margins
• Earnings per Share (EPS) & Price to Earnings (PE) Ratio
• Current Ratio, Debt, & Cash/Short Term Investments
• Operating/Free Cashflow & Capital Expenditures
• Share Buybacks & Dividends
• Potential Risks
• Intrinsic Value - Discounted Cashflow Valuation (DCF)
• Conclusion

Disclaimer: At the time of this writing, I did not own any shares of Micron. I may or may not by the time you are reading this. I have tried to keep this blog post completely neutral, based on facts, but every valuation has built in biases. You should do your own research or consult a professional before making any investment decisions. This blog post is not financial advice and is meant for informational/entertainment purposes only.

What is Micron? What does Micron do?

Micron is a world leader in memory and storage solutions that operates in 17 different countries and has over 43,000 team members. Founded in 1978 as a four-person semiconductor design company, Micron became a public company in 1984. They are headquartered in Boise, Idaho, United States. Micron focuses on manufacturing memory and storage technologies such as DRAM, NAND, and NOR memory. They currently have over 48,500 patents and are the 4th largest semiconductor company in the world.

The current CEO of Micron is Sanjay Mehrotra, following previous CEO Mark Durcan’s retirement in 2017. Sanjay Mehroto co-founded SanDisk in 1988 and served as CEO from 2011 until its sale in 2016.

Micron operates within 4 main business units:

• CNBU (Compute and Networking Business Unit):

  The compute and networking business unit covers memory products and solutions that are sold into client, cloud server, enterprise, graphics, and networking markets.

• MBU (Mobile Business Unit):

  The mobile business unit includes memory products that are sold into the smartphone and other mobile-device related markets.

• SBU (Storage Business Unit):

  The storage business unit includes SSDs and component level solutions that are sold into enterprise and cloud, client, and consumer storage markets.

• EBU (Embedded Business Unit):

  The embedded business unit offers memory and storage products that are sold into industrial, automotive, and consumer markets. It includes discrete and module DRAM, discrete and manager NAND, NOR, and SSDs.

Micron's Revenue

Memory and storage chips have been a very cyclical business in the past. Years with low demand generally push prices down and margins lower, as companies must offload their supply. This can be seen in their revenue numbers over the past 10 years. As an example of price fluctuations, the average selling price of DRAM was up 18% in 2017, up 36% in 2018, down 30% in 2019, down 34% in 2020, and up 8% in 2021. Micron’s average selling price for NAND during the same time periods was down 10%, down 13%, down 47%, down 9%, and down 12% respectively.

As shown in the chart below, Micron’s revenue for FY ending September 2021 was $27.7 billion, representing an increase of 29.23% from the previous years $21.43 billion. This also represents a 5-year CAGR of 48%, and a 10-year CAGR of 43%. The graph also allows you to see the cyclical nature of the industry. Despite the cyclical nature, it is clear to see revenue has steadily gone up through the cycles. This is likely to continue into the future, with the world’s demand for chips increasing as technology innovation continues.

The table below shows a breakdown of Micron’s revenue by technology, business unit, and geographical location. As you can see most of their revenue is driven by DRAM sales. According to TrendForce, DRAM sales are expected to grow by only 0.3% in 2022, with average selling price expected to fall 15%. Meanwhile NAND sales are predicted to grow 7.4%, though average selling prices are expected to drop 18%.

Micron's Margins

Looking at a company’s margins allows you to see how profitable they are, and if they are trending in the right direction. As previously mentioned, Micron’s margins follow the cyclical nature of the industry, dropping in years when demand is low/supply is high.

Micron’s gross margin, operating margin, and net margin for FY 2021 was 37.62%, 22.46%, and 21.15%, respectively. This is up from FY 2016 when their margins were 20.2%, 1.32%, and -2.2%, respectively. Going back 10 years ago to 2011, their gross margin was 20%, operating margin was 8.59%, and net margin was 1.9%.

Micron's Earnings per Share (EPS) & Price to Earnings (PE) Ratio

Earnings per share is calculated by dividing the company’s profit by the number of outstanding shares. It is one of the most common metrics looked at to determine a company’s profitability and is used in the price to earnings calculation. It is important to remember that earnings per share may not tell the whole story due to extraordinary items. It is important to read the reports, so you fully understand it. PE Ratio is multiple of earnings that you are paying per share.

Micron’s earnings per share (TTM) is currently $6.46, which gives it a PE Ratio of 12.56.

Micron’s average PE ratio over the last 10, 5, and 3 years is ~6.19, ~12.72, and ~17.16 respectively. I calculate this by taking the daily close every day over the respective time frame and dividing this by the EPS over the trailing twelve months. This gives us the daily price to earnings ratio, which I then get the average for each time frame.

Micron's Current Ratio, Debt, & Cash/Short Term Investments

The current ratio allows investors to see if a company is able to pay short term liabilities. At the time of writing Micron’s current ratio was 3.1, which means they have 3.1 times more current assets than current liabilities, which suggests they should have no problem paying short term liabilities.

The following graph shows Micron’s total current liabilities, total current assets, total debt, and cash/short term investments over the last 10 years. This allows you to see how their balance sheet has transformed over time. It also allows you to visually see if a company has a significant amount of debt that they may not be able to pay back. As you can see Micron’s balance sheet looks very healthy, with their current assets climbing almost every year, and total debt dropping/staying flat.

Micron's Operating/Free Cashflow & Capital Expenditures

The intrinsic value of any investment is the sum of future cashflows discounted back to present day. The hardest part of any valuation is estimating those future cash flows. In this section we look at Micron’s historical cash flows, and capital expenditures. Operating cash flow is the cash that is generated from normal business operations, while free cash flow subtracts capital expenditures from that.

The following graph allows you to see operating cash flow, capital expenditures, and resulting free cash flow over the last 10 years.

Micron's Share Buybacks & Dividends

In May 2018, Micron authorized 10 billion in buybacks of common stock, which has no expiry and no obligation to be fulfilled. In the first quarter of 2022, they have repurchased 3.6 million shares of common stock for $259 million, which equates to an average price of $71.94. So far, they have repurchased $4.3 billion from the authorization amount, which leaves $5.7 billion available as of the end of the first quarter 2022.

The table below shows their history of share buybacks.

On August 2nd, 2021, Micron’s board of directors announced they were starting a quarterly dividend of $0.10 per share, which at current market price equates to 0.49% annual dividend yield.

Micron's Potential Risks

Every business comes with certain risks. It is important for the investor to understand these risks and decide if they are manageable or if they will affect the business going froward. We have listed a few risks that Micron faces below.

- Cyclical Nature:

As previously mentioned, the chip industry is very cyclical and like most businesses driven by supply and demand. This means there can be high volatility in average selling prices, revenues, and margins. Micron and some competitors are investing on more production capabilities which will increase worldwide supply. If this increased supply is not equally matched by demand, prices will drop.

- Competition:

The chip industry also faces steep competition and will continue to in the future. To maintain a competitive advantage over the competition Micron must continue to develop and produce new products and technologies. Some of the main competitors of Micron are Samsung Electronics, SK Hynix, Intel, Kioxia Holdings Corporation, and Western Digital Corporation. Some countries such as China are also heavily investing in the semiconductor industry.

- Customer Concentration:

For the last 3 years, ~50% of revenue was from Micron’s top ten customers. If Micron loses some of their top customers, it can have a large negative effect on revenue, particularly those customers in China. This recently this happened with their customer Huawei Technologies.

- Geographical/Political Risks:

In 2021, 56% of Micron’s revenue came from customers with headquarters outside of the United States, and 89% of revenue was from products shipped to locations outside the United States. A majority of Micron’s DRAM production is from Taiwan, which currently faces risks from China. Most of Micron’s long-lived assets are also located in Taiwan.

Micron's Intrinsic Value - Discounted Cashflow Valuation (DCF)

To get our intrinsic value, we will be using our DCF calculator that allows you to change certain values such as revenue growths, operating margins, and cost of capital to see how it affects the intrinsic value. Our calculator instantly does the math and discounts cash flows back to present day to get the current intrinsic value.

For our valuation, we came up with an intrinsic value of $101.64 per share, which at time of writing represents 8% upside from the current price of $94.12. The main assumptions I used were:

• Revenue Growth Year 1: 15% - Analysts predict 16.4% for current year, despite TrendForce's forecast on demand and pricing.
• Revenue Growth Years 2-5: 12% - Analysts predict 20.10% for next year, I assume there will be another down cycle within the next 5 years. This would give them revenue of ~$53.6 billion per year in 5 years.
• Operating Margin Year 1: 25% - Operating margins have risen through the cycles. Last year operating margin was 22.44%, with TTM being 28.69%. I believe the operating margin for current year will be ~25%.
• Operating Margin Year 10: 18% - I don't expect operating margins continue to rise long term through cycles, due to increased competition, lower prices, and the risk of China/Taiwan.
• Cost of Capital Year 1: 7.65% - I calculated the cost of capital to be around 7.65% for Micron. For this I used a cost of debt of 3.52%, an implied equity risk premium of 5.17%, and a cost of equity of 8.065.
• Cost of Capital Year 10: 6.4% - For the cost of capital in year 10 I have made the assumption that it will match typical mature companies, which is risk-free rate + 4.5%.

If you disagree with our assumptions, or want to change some of the variables to see how it affects the intrinsic value, head over to our DCF calculator (100% free!)

We used the following assumptions in our calculation to arrive at this value:

Conclusion

Micron’s a great company with solid financials. Going forward their industry is forecasted to have tremendous demand, which Micron is positioning themselves to take advantage of with their $150 billion investment in production. This blog post has gone over all their financials, risks, and Micron’s intrinsic value calculation. Hopefully after reading this post, you better understand their business, and are in a better position to make an investment!

In my personal opinion, the current price does not offer as much of a discount as I would like for the risk involved with China/Taiwan, the amount of competition, and the cyclical nature. If TrendForce is right about prices dropping in 2022, it may provide better buying opportunities going forward. If the price drops enough that I think the upside is worth the risk I will start a position.