The Party Rages On for Micron Technology

Just about the best-case scenario is playing out for memory chip manufacturer Micron Technology (NASDAQ: MU). Demand for the company's DRAM and NAND chips is high, supply is constrained, costs per bit are dropping, and prices per bit are soaring. During the fiscal fourth quarter, Micron produced $2.4 billion of net income on $6.1 billion of revenue. That's up from just $3.2 billion of revenue and a net loss during the same period last year.

Historically, periods of lush profits for Micron have never lasted all that long. Like in any commodity market, a prolonged period of elevated prices encourages capacity expansion, which eventually erases the gap between supply and demand. This process can take a while, as there's a lag between when capital is committed to new capacity and when that capacity comes online. But it has played out without fail in the past, and there's no reason to believe it won't play out again in the future.

Management's optimistic

Micron's management tried to downplay this risk during the fourth-quarter conference call, pointing to strong demand from cloud computing customers and the accelerating shift from hard drives to solid-state drives as tailwinds that will help keep pricing strong. CEO Sanjay Mehrotra, who took the helm in May, expects the DRAM market to be undersupplied for the remainder of this year, followed by a period of "healthy demand/supply balance" throughout 2018.

Asked to elaborate on pricing going into 2018, Mehrotra said that a healthy industry environment is one where per-bit price declines are less than or equal to per-bit cost declines. In other words, Mehrotra is predicting that the epic surge in DRAM prices that has taken place this year is coming to an end. As long as Micron can cut manufacturing costs at least as quickly as prices fall, the bottom line will hold up. But if prices start falling at a faster rate, profits can plunge quickly.

DRAM per-bit selling prices surged 57% year over year for Micron during the fourth quarter. Combine that with a 32% increase in bit volume and a 20% decrease in per-bit costs, and it's no mystery why profits are soaring.

Mehrotra sees new demand from emerging areas like autonomous vehicles as a key reason why demand will remain strong: "So much data is being generated by autonomous vehicles that it requires fast processing both within the vehicle as well as on the cloud. So, I think demand trends for the foreseeable future continued to be strong and that bodes well for our industry."

The foreseeable future

Here's the problem: The "foreseeable future" in the memory chip industry doesn't extend very far. Predicting where memory prices will be a year from now is mostly a guessing game, a function of not only demand but also supply.

There are certainly reasons to believe that demand for DRAM and NAND will be strong in the coming years. Autonomous vehicles, artificial intelligence, and the shift away from hard drives are all tailwinds for Micron. But the smartphone market went from zero to 1.5 billion devices in the span of a decade, and Micron lost money in half of those years. Even a once-in-a-generation technological revolution wasn't enough for Micron to be consistently profitable.

Micron's record-breaking fourth quarter is certainly something for investors to celebrate, and strong pricing may very well continue into 2018. But being unrealistic about the cycles of the memory chip industry is a recipe for disaster.

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Timothy Green 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.