When it released earnings yesterday, chipmaker Micron Technologies (MU) reported a significant, and surprising to many people, beat on both the top and bottom lines. EPS of $1.05 was way over the $0.79 consensus estimate, and was achieved on sales of $4.79 billion, just above the $4.69 billion anticipated.
A pop in the stock on those kinds of results is not surprising, but even so, the jump of over thirteen percent that followed the release is eye-catching. Under most circumstances, it would also be big enough to put me off buying the stock, but not this time.
The reaction was so big because a beat of any kind was so unexpected. As you can see from the chart below, the last year or so has been bad for Micron, indeed for semiconductor stocks in general. It is a highly cyclical business, and the fact that memory is essentially a commodity means that there are often oversupply issues within those cycles.
We have been going through one of those periods of oversupply after prices spiked last year, and the associated problems have been exacerbated by both the trade war with China and the sanctions on Huawei.
Micron’s beat, therefore, fell into the “not as bad as was feared” category, another thing that would normally put me off buying the stock. It can be easy to lose sight of the fact that not as bad as feared is still bad, and results like that often result in a sharp pullback after an initial pop. What is different here is that we are not talking about a smaller loss than expected, we are talking about a company handling adverse market conditions better than expected and continuing to make good profits as a result, while hinting at a more optimistic future.
That is good in the medium to long term, but there is another reason why waiting for a pullback in the short term could be a mistake.
Market conditions for chip and memory makers have been deteriorating for some time, and the assumption was that that would continue well into the second half of this year. Give that Huawei was a major customer of many of those companies and that China in general was simultaneously a big customer and big supplier to the industry, that was a reasonable assumption.
A resolution to the trade dispute with China would therefore change that outlook somewhat, but I am not so naïve as to believe that just because administration officials say optimistic things every now and again, we are on the verge of a deal. Nor do I believe that the Chinese will roll over and agree to a deal that massively benefits the U.S. in any way, but that isn’t the point.
In trading, perception is reality, and logic suggests that there will be a more positive perception of the trade issue next week.
President Trump is due to meet President Xi this weekend, and, politically, a positive tone to statements and press releases would benefit both leaders. Not to be too cynical, but that will mean that, whatever the results of the meeting, optimistic comments are on the cards.
Any kind of softer tone on Huawei, or even just more platitudes about a deal being “close” would cause a positive reaction in chip stocks next week. That makes this a decent entry point into MU from a short-term perspective, but their earnings contained reasons to be optimistic beyond that as well.
They responded to the weakness in the business in the best way a company can. They cut operating costs to $774 million, well below most estimates. That enabled them to post gross margins of close to 40%, boosting cash flow in the process.
That is essentially why I believe MU is a buy, even after yesterday’s spike. They showed in their earnings report that they have adjusted to market conditions as needed, but unlike during some periods of weakness in product pricing, they have remained profitable and maintained good margins, even as prices have fallen. That leaves them with a big pile of cash on hand and gives the ability to position themselves quickly for expansion when the semiconductor market turns.
So, even though a massive jump such as we saw yesterday in any stock is often a turnoff, particularly when it seems to be a relief rally more than anything, Micron is different. There may be a slight pullback over the next day or two, due to the size of the pop, but both short- and long-term dynamics indicate that there is still plenty of room to the upside.