Micron Technology Investors Should Brace for Painful Days Ahead

The odds were stacked against Micron Technology (NASDAQ: MU) going into its fiscal first-quarter earnings report in mid-December, and it wasn't surprising to see the company disappointing investors by missing analysts' revenue estimate and providing weak guidance. The tables have been turning against the memory specialist over the past few months as the memory industry has been moving toward a period of oversupply, and it looks like the bad times are here to stay at least for a while.

Going downhill

Micron investors and analysts were already expecting a decline in Micron's earnings and revenue going forward because of the changing memory industry dynamics. But what the company ended up predicting is way worse. It expects its top line to crash nearly 19% year over year in the second quarter, while Wall Street was looking for only a slight drop.

Meanwhile, its earnings per share are predicted to crash 38% on the back of severe margin erosion. More specifically, Micron expects its gross margin to range between 50%-53% in the current quarter, compared to the prior-year period's 58.4%.

This isn't the first time that Micron has failed to deliver upbeat guidance in recent months. The company was already witnessing a drop in prices of NAND flash memory, and now the DRAM (dynamic random access memory) business is going the same way. According to Micron, DRAM demand "weakened through the course of our fiscal first quarter." Management has further clarified that they expect the weakness to continue and have limited near-term visibility.

However, Micron also pointed out that DRAM demand growth is expected to pick up from the third quarter of its fiscal year once inventory adjustments at its customers are over. Additionally, it predicts demand conditions to improve in the second half of calendar 2019. That would be critical to Micron's turnaround, as DRAM supplies 68% of its total revenue.

On the other hand, the NAND flash business also needs to show some signs of life, as it accounts for 28% of revenue. But the conditions here aren't any better, as suppliers have "elevated levels of inventory," according to Micron. In simpler words, Micron is facing a supply glut in its key markets, and that's forcing the company to slash capital expenditure (capex) by 13% for the fiscal year so it can cut output.

All in all, Micron is taking desperate measures to combat the memory industry oversupply, while giving investors hope that things will improve once the inventory correction is over in a couple of quarters. But that doesn't guarantee a turnaround for Micron.

Trying to get a handle

Micron needs demand to grow at a faster pace than supply if it is to turn its business around. The good news is that it isn't the only one looking to cut down production and slash capital expenses in a bid to turn the demand-supply balance.

Samsung, the global leader in memory chips, is reportedly considering lowering the pace of capacity expansion in 2019. The South Korean giant was originally looking to expand DRAM bit production by 20% and NAND by 40% in 2019, according to its third-quarter earnings call in November. But it is reportedly mulling NAND bit growth of 30% and DRAM bit growth of less than 20% in the new year.

Micron competitor SK Hynix is going down the same path. The company will be managing the size of its capital expenditure on a quarter-by-quarter basis instead of coming up with an annual plan as it tries to contend with a demand slowdown that's triggered by a drop in smartphone and PC sales.

So all the key memory industry stakeholders are trying to keep a handle on supply to ensure that the downturn doesn't last for long. Additionally, the memory industry might experience an uptick in demand on the back of a potential recovery in PC and smartphone shipments. Market research firm Canalys believes that the global PC market will recover in 2019 after declining for seven years.

Meanwhile, IDC predicts that smartphone shipments will increase 2.6% in 2019 after a 3% drop last year, and experience low single-digit growth through 2022 thanks to the emergence of new technologies such as fifth-generation wireless networks. A potential recovery in these markets, combined with leaner memory inventory levels in other fast-growing markets such as data centers, should lead to a favorable demand-supply balance.

However, there's a slight chance that Micron might miss out on a potential recovery because of its capex control. That's because Micron held around 22.6% of the global DRAM market, compared to Samsung's 45% share and Hynix's 28%, in the first quarter of 2018. As such, it can be assumed that its rivals have greater infrastructure and capacity to produce chips. And because Micron has decided to reduce its capital expenditure, it might not have enough capacity to address demand when the recovery begins.

Investors would be prudent to look for concrete signs of a turnaround before going long.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.