/Microns Inventory Needs To Drop First

Microns Inventory Needs To Drop First



Since late 2018, shares of Micron Technology (NASDAQ:MU) has increased more than 45%. What is amazing is that the market appears to shed off the bad news of continuously sliding DRAM/NAND memory price and resulting downward revisions of forward revenues (Point A in Figure 1A). Probably, the only remaining positive information that the market has used to support the stock price is the Micron’s CEO Sanjay Mehrotra’s uplifting guidance during the 1Q earnings call:

“But, as we have said that second half of this calendar year, we do expect that bit growth in DRAM to continue on a quarter-over-quarter basis, both sequentially as well as on a year-over-year basis. And that is already, we are guiding to bit growth in DRAM for our FQ3, and that should continue in FQ4 and for the rest of the year as well. And in NAND, there is of course the seasonality in the second half of the calendar year. And of course, we expect effect of elasticity also to help improve the demand.”



It also appears that management’s positive forecast about the product demand in 2H 2019 may not be shared by the Wall Street analysts, since there have been very few upward revisions in distant forward financials. On the other hand, as Micron has been experiencing a typical demand-supply mismatch and resultant overhang inventory, the demand outlook which companies have little control over is just half of the picture, while supply and production, which have been adjusted by recent capex cutback, seem to provide a more telling story of company revenue outlook. On the inventory front, a representative from Samsung said the following on the earnings call in January:

“The company is optimistic about the last two quarters of 2019, when it expects demand for chips and OLED panels to pick up thanks to seasonal demand and customers finishing their inventory adjustments.”

As semiconductors’ inventory turnover often leads the DRAM/NAND price cycle, Micron’s next few quarters’ inventory changes will be pivotal in predicting its future revenue and stock price movement. In this post, I will look into Micron’s inventory changes specifically.

Micron’s Inventory

Until recently, Micron’s inventory has been mainly dictated by the demand of smartphones and PCs. Due to Intel’s (NASDAQ:INTC) PC shortage and the slowdown of the smartphone demand from China uncertainty, Micron’s inventory has increased significantly in the recent period (Figure 1). Furthermore, the changing structure of the inventory provides more interesting implications on future product demand. In terms of inventory structure, we were able to demonstrate the breakdown of Micron’s inventory among raw materials, work in progress, and finished goods, which suggest several interesting implications (Figure 1).

First, it is clear that both raw material and work in progress inventory soared recently, but finished goods inventory stabilized. It is also obvious that the raw material and work in progress inventory which are more under company’s direct control tend to move together over time. The good news of a rising raw material and work in progress inventory would reflect the fact that management has forecasted and prepared for a favorable future demand by stocking up these types of inventory.

Similarly, a flattening finished goods inventory is also considered positive since it indicates an increase in shipments. As I am trying to read more into the different trending of the three types of inventory, a slowing finished goods inventory buildup is always the first signal to a recovery. The expected recovery is further confirmed by which is followed by management decision to simultaneously building up raw material and work in progress inventory, as the company will need both more amid their favorable short-term forecast. For Micron, the current three inventory movements suggest that both product market and management forecast will improve into 2H 2019.



If you think that there is merit in the above argument, it would stand to reason that the changing inventory should signal future product demand or stock price movements. For example, the inventory turnover usually moves ahead of semiconductor prices. A decline in inventory and increase in shipments typically lead to an upturn in bit growth, followed by a rising ASP, semiconductor price cycle, and eventually, rising stock prices. Again, this sequence of events is not just conjecture but consistent with the history. In Figure 3, Micron’s inventory ratios had to come down first before Micron stock price started rising. In fact, the drop in inventory ratios tends to lead the rise of Micron’s stock price, as repeatedly shown by the blue dotted lines. A more detailed analysis showed that inventory ratio drops, on average, led stock price increases by 2 quarters.



A Brighter 2H 2019?

So, what does all this mean to Micron’s stock from here on? As inventory may be affected by the changes in revenue, a low 43% inventory to revenue ratio has been hit Q3 2018, while over 88% inventory ratio in Q1 2019 reflected the overhanging channel inventory from their main customers like AMD (NASDAQ:AMD) and Nvidia (NASDAQ:NVDA) due to the depressed crypto use and slower gaming growth due to China slowdown. At this time, the bullish analysts seem to dominate the Wall Street thinking mainly based on CEO’s favorable outlook and predict the revenue will rise over $6 billion with a declining inventory. The combination will forecast the inventory ratio onto a downward trend, starting 2H 2019. By the end of 2020, the inventory ratio will drop close to 60% (Figure 4). It is important to point out that a declining inventory ratio requires that a high finished goods inventory needs to be turned over to a high revenue and hopefully a higher stock price. Micron’s inventory has to drop first before its stock price will rise.



Takeaways

Street analysts and the stock price have been optimistic about Micron’s turnaround in 2H 2019 mainly based on CEO’s favorable guidance, although there are more and more signs indicating China’s uncertainty, crypto weakness, and the Fed’s tight interest rate policy will become headwinds blown over by 2H 2019. Micron’s rising raw material and work in progress inventory and a flattening finished goods inventory are consistent with CEO’s positive outlook. From analysts’ forecasts on Micron’s forward financials, I saw the same optimism in their rising revenue estimates and declining inventory into and after 2019. The bullish forecasts rely on the assumption that smartphones, PCs, and gaming demands will return to clear Micron’s overhanging inventory. Whether it will happen is everyone’s guess. But history shows that Micron’s inventory has to come down for at least 2 quarters before stock prices will rise.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.