Micron’s Share Price Has 20% Downside If DRAM Pricing Falls Further In 2016 And 2017

Leading memory chip maker Micron Technology (NASDAQ:MU) has seen a more than 50% decline in its stock price so far this year. While the weak macro environment and adverse currency headwinds have in general slowed down growth in the semiconductor industry, Micron’s business is primarily being impacted by the oversupply situation and declining prices in the DRAM market. The company derives approximately 55% of its valuation (as per our estimate) and over 60% of its revenue from the DRAM business, and thus any adverse development in the segment has a considerable impact on Micron’s valuation.

We expect DRAM prices to continue declining, but forecast the rate of decline to slow down next year onward. Also, we forecast DRAM gross margin to decline only marginally this year and remain stagnant for the rest of our review period. In this article, we present a scenario where our current $23 valuation for Micron could decline by 20%. (You can see the modified model and the resultant impact on key financial estimates here)

See our complete analysis for Micron here

Why Are DRAM Prices Declining?

DRAM prices had stabilized in the last two years on account of the growing smartphone and tablet demand. However, given the continued weakness in PCs and the slowing smartphone growth, prices have declined significantly this year, and the trend is expected to continue into next year as well. Even in the last 2-3 months (which are typically seasonally strong quarters), prices continued to fall on account of declining PC sales and weak smartphone and server sales, owing to macro-economic uncertainty. The declining prices in turn put pressure on Micron’s gross margin, and the company has seen its bottom line shrink by more than 50% over the past year. Key factors responsible for the decline in prices are:

– Intense competition (despite industry consolidation) and declining PC sales: While the global DRAM market had numerous players a few years back, it is now essentially an oligopoly. Samsung Electronics, SK Hynix and Micron are the top three DRAM players, accounting for more than 90% of the market. ((Why DRAM Pricing Is A Key Concern for Micron, Market Realist, July 10, 2015)) While the consolidation has reduced the DRAM supply in the market, the sluggish PC demand has led to a decline in DRAM demand. Demand has fallen faster than supply, creating an oversupply situation in the DRAM market. Research firm Gartner expects the oversupply situation in the DRAM market to continue in 2016, leading to a 13.6% decrease in worldwide memory spending next year. ^[1] With Micron forecasting DRAM industry supply bit growth to be in the mid-20% range in calendar 2015 and in the low to mid 20% range in calendar 2016, DRAM prices will fall drastically.

– Samsung selling DRAM at lower price points: In order to capture a higher market share, Samsung has been selling DRAM at a lower prices compared to its competitors. Samsung is the only producer that makes a significant portion of its DRAM memory using 20nm fabrication technology. Finer manufacturing technology allows the company to make memory ICs smaller and cheaper, which enables Samsung to sell its memory at lower price points without affecting its gross margin. ^[2] Samsung was the first company to start producing chips on 20 nm (in March 2014). Micron started using 20 nm much later in Q4 2014. ^[3] Samsung is now gearing up to start production of DRAM using 10nm-class (allegedly 18nm) process technology sometimes next year, which will put even more pressure on prices and competitors. ^[4]

Why We Believe That Rate of Decline In DRAM Pricing Will Slow and Gross Margins Will Stabilize

Our model is based on the assumption that the macro environment will improve in the second half of 2016, which will lead to an increase in Micron’s DRAM demand and consequently help lower the decline in DRAM prices. We also expect an increasing proportion of demand from non-PC market to drive future growth.

Over the last few months, Micron has been allocating less production to PCs and continuing to shift more bit production towards the other faster-growing segments — namely mobile devices and cloud servers. In Q4 2015, PC as a percentage of Micron’s DRAM revenue was in the low 20%, down from about 30% in Q3 2015. The mobile and server business was in the low 30% and low to mid-20% ranges, respectively, up from high 20% and low-20% ranges in the prior quarter, respectively. The mobile device and server segments are the fastest growing in terms of DRAM demand, with annual growth projected in the range of 30% to 50%. Additionally, the server business has a demand profile that is less sensitive to price fluctuations in the market. Macro uncertainty has slowed growth in the mobile device and server markets, but the long-term growth potential of these segments remains intact.

Lastly, we believe that the transition to 16 nm will enable Micron to lower its manufacturing cost, in turn helping the company retain its gross margin despite the decline in DRAM prices. Micron is currently incorporating the new 16 nm technology at its plant in Japan. The technology is likely to lower its manufacturing cost and improve its chips’ performance.

What Happens If DRAM Prices Continue To Decline Significantly in 2016 & 2017

If the global economy continues to stagnate longer than we expect, the end market might not generate the demand needed to effectively consume the new DRAM chips produced on the advanced nodes. This could result in a longer period of over-supply in the DRAM market (or even worsen the situation), resulting in a consistent decline in DRAM prices for the next two to three years. Also, Micron’s ability to reduce costs may be constrained due to the adjustments the company is making to its diverse product portfolio, including an increasing proportion of DDR4 and mobile DRAM.

If DRAM prices decline by 25% each in 2016 and 2017 (as compared to our current estimate of a 15% decline in 2016 and 10% decline in 2017) and DRAM gross margins decline by one percentage point for the next three years (as compared to our assumption of relatively stable margins), our valuation for Micron will decline by 20%.

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1. Gartner Says Worldwide Semiconductor Capital Spending to Increase 2.5 Percent in 2015, Gartner Newsroom, July 14, 2015 [↩]
2. Samsung putting pressure on DRAM prices, KitGuru, June 13, 2015 [↩]
3. Micron’s Strategy for Coping with Declining DRAM Prices, Market Realist, October 1, 2015 [↩]
4. Prices of DDR3 and DDR4 continue to drop, set to decline further, KitGuru, October 2, 2015 [↩]