Micron (MU) , often seen as a bellwether for the semiconductor sector (SOXX) , is setting a solid precedent for a recovery in at least the market sentiment around semiconductors.
Shares of the Boise-based chip maker were off to a hot start in pre-market, surging by more than 9% at highs, and building back from a miserable month of May that saw shares decline double digits amid trade war troubles.
The move for Micron comes after the company reported fiscal third quarter that beat severely tempered analyst estimates and offered some mixed guidance into the coming quarter. However, likely most important for the stock move was the strong outlook for a normalization of supply and demand in memory.
"We are confident that the long-term demand outlook for memory and storage is compelling, driven by broad secular trends such as AI, autonomous vehicles, 5G, and IoT," CEO Sanjay Mehrotra told analysts after the bell on Tuesday. "The new Micron is well positioned to take advantage of these trends, with innovative products, a responsive supply chain, and well-established relationships with customers worldwide."
The company noted that it will cut capex to a "meaningfully lower level" to deal with the oversupply lingering over the sector, which many investors in semiconductors see as a sign that inventory across the industry will become more favorable to memory pricing in the future.
"Our assessment is that further cuts in CapEx and bit supply will be required to return the industry to a healthy supply-demand balance," he commented.
Wall Street has lauded this decision as prudent and a logical shift from former industry dynamics.
"We view this decision as a significant change from past memory cycles where market share increases were the driving factor in capacity growth decisions," Stifel analyst Kevin Cassidy commented. "We continue to recommend owning the MU shares as the industry proactively adjusts supply to meet the true end market demand."
Analysts noted that the reduction in capex and a pickup in demand, as any economist will tell you, is a positive dynamic for the entire sector, especially as many companies continue to target a recovery into the year end.
"MU is starting to see signs of a demand recovery in both DRAM and NAND, and customer inventory levels appear to be improving," Deutsche Bank analyst Sidney Ho said. "We remain encouraged by MU's disciplined capex and utilization strategy, with FY20 capex expected to be down meaningfully and MU also cutting NAND wafer starts, and this discipline, if followed by other vendors, should help stabilize DRAM/NAND pricing."
Additionally, the company added nuance to the debate over Huawei impacts, a key factor for the company considering it generates about 60% of its revenue from mainland China and Hong Kong, with Huawei accounting for about 13% of total revenue.
"Micron immediately suspended shipments to Huawei and began a review of Micron products sold to Huawei to determine whether they are subject to the imposed restrictions," Mehrotra said. "Through this review, we determined that we could lawfully resume shipping a subset of current products because they are not subject to Export Administration Regulations and Entity List restrictions. We have started shipping some orders of those products to Huawei in the last two weeks."
If not for the current embargo, the quarterly results would have been much stronger, he noted.
The resumed sales to Huawei suggest that demand can indeed pick up in China as well, buoying hopes that the sector can overcome the trade war that has remained a significant tamp on sales overall.
Further, Mehrotra noted that partners competing with Huawei are likely to demand increasing shipments of chips should the fluid situation in China take any turn for the worse.
"Keep in mind that in certain countries 5G has already started to be deployed, such as Korea and there are of course leading suppliers, other than Huawei as well for 5G," he commented. "There is no doubt that 5G will bring about greater applications for memory and storage, not only in smartphones, but also in machine-to-machine on the IoT front."
Still, the situation in China remains a headline risk. If Micron is barred further after announcing its work around plans, Samsung (SSNLF) and Hynix (HXSCL) could be key entities to address Huawei's lessened supply and overtake this aspect of the business.
It will be incumbent upon Micron to ensure that it can address market opportunities elsewhere in the midst of the fluid situation.
Overly Optimistic?
While the optimism on the dynamics are palpable in the stock move for Micron, sales declining nearly 40% year over year, margins being squeezed, and a hefty supply still on the books, not everyone was convinced a reversal in fortunes is nigh.
"I plan to re-establish my short at $37-$39 as the $510 million rise in inventories (to nearly $5 billion) was astonishing in the face of a sequential decline of more than $1 billion in sales," Seabreeze Partners Management president Doug Kass commented after the earnings release. "Management is expressing that it sees a small pickup demand, but color me a skeptic."
Morgan Stanley analyst Joseph Moore also picked up on this dynamic, suggesting the wide price swing to the upside is missing the actual supply dynamics underneath the management commentary.
"Supply/demand imbalance is getting wider, not narrower, as evidenced by days of inventory that continue to climb well beyond any previous precedent," he wrote in a note to clients. "We were a bit surprised that the company did not take further action to keep inventory under the self-imposed 150 day cap."
Based on the actual data presented, he was less confident than many of his peers in the company's continued calls for market recovery.
"Demand should improve, but it does not seem likely to overtake production in the second half, or even in 2020," Moore added. "With that backdrop, we don't see a strong case to buy the stock at prices higher than book value."
While many remain bullish on the company's outlook, FactSet notes a slew of price target cuts following the earnings as skepticism on the stock trend remains. The company's lack of additional buybacks might speak to some uncertainty on the part of the company itself as well.
With shares up significantly now, it would be unlikely to see a full scale reversal in fortunes, but it would be less surprising to see the gains tempered after the open.
For tech columnist Eric Jhonsa's seven key takeaways from the earnings call, click here.
