Upside in Micron Despite Recent Price Volatility

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Micron Technology's stock price has experienced some volatility in the past three months, down as much as 20% from its six-month highs. Downward pressure on the stock's performance has come from a number of directions, including weakness in the PC end market, overall weakness in DRAM pricing, and rumors that Samsung will increase capacity in memory markets, disrupting the current supply and demand balance. Despite some of these negative influences, we think there is still considerable upside, with a valuation that could even approach $50.

Addressing the concernsLast year, Microsoft discontinued support of its Windows XP platform, pushing forward an upgrade cycle that was responsible for a particularly strong year in PC shipments. While this was good for Micron in 2014, DRAM sales won't be benefiting from such a push this year. The PC end market has historically represented about 30% of the DRAM end market, but the segment continues to experience continued weakness. This weakness, however, has long been anticipated and should be priced in already. In the long run, the mobile market will be the growth driver for the DRAM market, something we'll touch on later. DRAM pricing also tends to be seasonally weak during the first quarter and should recover into the rest of the year.

Spot price for 3-gigabit DRAM module (InSpectrum Technology)As for the rumorsthat Samsung may oversupply the market with excess capacity, the fears are overblown. Samsung is the world's largest DRAM and NAND supplier, and memory segments account for a large proportion of its profitability. The company has little incentive to bomb the market and shift the supply and-demand balance. DRAM supply is expected to remain tight going into the rest of the year, which is good news for the market.

The good news aheadOn the DRAM side, the company's growth vectors come from two fronts. The first, as we mentioned earlier, is in the mobile market, which will continue to increase in both units shipped and gigabytes per unit. Currently, the average mobile device contains around 700 MB of DRAM. The industry is on a trajectory to average 2 GB per smartphone in the next two years. The next iPhone is currently rumored to have its memory capacity increased from 1 GB to 2 GB of DRAM, while the Samsung S6 is expected to ship with 3 GB of memory.

The second area for growth in the DRAM segment comes from smart TVs, a segment we don't often associate with memory products. Ultra-high-def and 4K TVs currently make up around 10% of the total LCD TV market of which 220 million units are sold annually, with some UHD TVs shipping with 4 GB of memory. Over time, the total bit demand from TVs alone could be as much two-thirds the size of the PC market by itself.

Another positive area for the DRAM business is the new agreement with Inotera. The new margin-sharing agreement, announced during the winter analyst day, will begin in calendar year 2016. Through margin sharing, Micron will also share in any of the downsides in the memory market, but given the strength of the market, this could offer Micron $0.30 to $0.60 of EPS upside in that year.

In NAND, we expect a recovery in the second half of this year. Micron has been under-earning its competitors SanDisk and Samsung in the NAND market. The big news is the new relationship with Seagate and the upcoming technology upgrades. The company expects that this development should lift margins on the NAND segment by 10%, which should equate to around $0.30 of EPS.

Micron is expected to do $0.75 of EPS in its fiscal second quarter, which annualizes to $3.00. Costs per bit in both DRAM and NAND have fallen historically around 5% quarter over quarter. In a flat to strengthening pricing environment, the margin expansions should account for an additional annual EPS accretion of $0.40 to $0.50.

Finally, the company announced $1 billion in stock buybacks last year and has been active in the market. This move should equate to around a 5% reduction in fully diluted shares, adding as much as $0.15 of EPS in 2016.

EPS contribution buildup into calendar year 2016With the stock trading at a P/E of 10 to 12 and the potential for $4 or more of EPS, we think that Micron could see levels closer to the higher range of $40 to $48.

This article originally appeared on Value Penguin.

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