No matter how much the market tries to focus on something else, it seems like the trade war always manages to find its way to the front and center position of market commentary and awareness. That was true again over the weekend as the Chinese government countered the Trump administration’s latest proposal of $200 billion in new tariffs with $60 billion of their own against U.S. goods. It keeps worries about what the actual impact and effect of a long-term trade war with our country’s largest trade partner is going to be. It’s definitely one of the most obvious factors that has contributed to the market’s increased volatility throughout the year, and I think it is going to continue to hold people’s attention throughout the year.
Naturally, one of the things this kind of uncertainty should make you do is to think about how it is going to impact the investment decisions you decide to make. In this day and age, it’s hard to find publicly traded companies that aren’t doing business in some way with China or other parts of the world, like the E.U., where the trade war is front and center – either by selling their products there or having them manufactured and produced there and then bringing them back home. The global nature of our economy, and the interconnectedness that we now live in means that even the smallest of companies are likely to have some element of exposure to global trade risk. That reality means that companies with known ties to China and other parts of the world are subject to even greater price volatility and general market risk.
The semiconductor industry has been an interesting proxy for trade war risk since mid-March when the saber-rattling first began in earnest. As measured by the iShares Semiconductor ETF (SOXX), the sector dropped a little over 50% by the end of April. It has rebounded a bit since then, but remains about 6% below its March high point. That has put a significant amount of pressure on a lot of big names in the sector like Intel Corporation (INTC), Applied Materials, Inc. (AMAT), Micron Technology, Inc. (MU) and Lam Research Corporation (LRCX), to name just a few that all remain well below – by at least 15%, if not more – their 52-week highs. And while I don’t think you should discount or dismiss trade war risk for these companies, I do think that a proper amount of perspective can help to determine how significant their risk really is versus what the market perceives their risk to be. It can also help to determine if a stock’s discounted price because of trade war fears could offer an under-appreciated bargain opportunity for value investors.
MU is a great example of what I mean. Last month, the company made headlines – but not in a good way – when they confirmed that a court in China had granted a preliminary injunction banning its Chinese subsidiaries from selling its products in the country. The stock has shown some resilience since that news broke, but remains under pressure, down nearly 20% from its high around $65 in late May. The perception, of course is that the measure, which seems clearly intended as a targeted countermove to U.S. tariffs, is going to have a significant negative impact on MU’’s business. The reality, however is quite different; the company estimated when they confirmed the injunction that the impact would only be about 1% of total revenue for the quarter, or about the same percentage that Chinese sales made up of their revenues over the last year. In the meantime, demand appears to remain strong, as the company also reaffirmed their own forward estimates of revenue. Another element that has contributed to strength for MU is the fact that supply of DRAM/NAND memory chips lags demand, which is keeping their pricing strong. It is possible that the negative revenue impact from the China sales ban could simply intensify the shortage; that could act as an extra pricing tailwind in the near-term.
As you’ll see next, there really is a lot of like about MU’s business right now, and while the stock’s negative price performance does suggest short-term risk exists, the fact is that does look like a very good value play right now.
Fundamental and Value Profile
Micron Technology, Inc. (MU) is engaged in semiconductor systems. The Company’s portfolio of memory technologies, including dynamic random-access memory (DRAM), negative-AND (NAND) Flash and NOR Flash are the basis for solid-state drives, modules, multi-chip packages and other system solutions. Its business segments include Compute and Networking Business Unit (CNBU), which includes memory products sold into compute, networking, graphics and cloud server markets; Mobile Business Unit (MBU), which includes memory products sold into smartphone, tablet and other mobile-device markets; Storage Business Unit (SBU), which includes memory products sold into enterprise, client, cloud and removable storage markets, and SBU also includes products sold to Intel through its Intel/Micron Flash Technology (IMFT) joint venture, and Embedded Business Unit (EBU), which includes memory products sold into automotive, industrial, connected home and consumer electronics markets. MU has a market cap of $60.8 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings more than doubled – growth was 128%, while sales growth was above 40%. Growing earnings faster than sales is hard to do, and generally not sustainable in the long-term; however it is also a positive mark of management’s ability to maximize their business operations. Net Income as a percentage of Revenues for MU is very impressive at more than 43% for the last twelve months and improving to nearly 50% in the last quarter.
- Free Cash Flow: MU’s free cash flow over the last twelve months is more than $7.5 billion. Cash and liquid assets are also almost $7.1 billion, against only about $5.9 billion of long-term debt.
- Debt to Equity: MU has a very conservative debt-to-equity ratio of .20. As already observed, their available cash and liquid assets is about $1.2 billion higher than their long-term debt, and with their high operating margin, there is clearly no issue with the company’s ability to service, or even to liquidate their debt.
- Dividend: MU does not pay a dividend.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MU is $25.45 per share. At the stock’s current price, that puts the Price/Book ratio at 2.05, versus a historical average of 2.26. The historical average puts the stock’s “fair value” at about $57.50, which is only about 10% away from its current price. That’s not very compelling by itself, but there are a couple of other measurements that, put together, offer what I think is an enhanced perspective. The stock’s P/E ratio – which, admittedly, I usually discount – right now is very low, at 5.12 times earnings compared to an historical average of 9.02. Also, their Price/Cash Flow ratio is 4.2 versus an historical average of 7.02. Those measurements are each 40% their historical averages. I think a 40% increase in the stock price is probably over-optimistic even as a long-term target since the stock’s 52-week high around $65 is higher than the stock has been since mid-2000 (the end of the “dot-com boom”); but it does put that high within sight, meaning that the opportunity in the stock right now is nearly 20%. That’s a very nice opportunity from a value-based standpoint!
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The diagonal red line traces the stock’s upward trend until May of this year and provides the reference for calculating the Fibonacci retracement levels indicated by the horizontal red lines on the right side of the chart. The stock’s decline from late May’s high at around $65 puts the stock in a clear, intermediate-term downward trend. More recently, the stock has round strong support in the $52 price range, just a little above the 38.2% retracement line. That support level also coincides pretty well with trend support from the 50-day moving average (not shown), indicating that the stock’s long-term trend should be expected to hold its strength for the foreseeable future. A break below $50, however would put the stock’s price decline above 20% and into bear market territory; I would take that as an early warning sign the long-term trend could reverse, with a further drop below $45 – about where the 50% retracement line sits right now – acting as confirmation of a bearish trend reversal.
- Near-term Keys: The question for a long-term, value-oriented investor is whether you would be willing to endure the kind of potential decline that could come if the stock breaks its current long-term trend support. I think the stock offers a great value right now; but if you think the stock’s current bearish momentum is going to extend further, it could be better to wait to see if the stock offers an even bigger value by consolidating around $45 per share. Short-term traders should wait to see the stock break above current pivot resistance around $57 before trying to buy the stock or work with call options to take advantage of a bullish swing. A drop below $50 could offer a reasonable short-term opportunity by shorting the stock or working with put options, with $46 as a pretty attractive near-term target price.