04:48pm EDT 23-Jun-98 Montgomery Securities (J. Joseph 415 627-2925) MU TXN TXN
Reality Bytes: A Weekly Report on Semiconductor Stocks
NATIONSBANC MONTGOMERY***NATIONSBANC MONTGOMERY***NATIONSBANC MONTGOMERY
REALITY BYTESA WEEKLY REPORT ON SEMICONDUCTOR STOCKS
June 23, 1998 SEMICONDUCTORS
Jonathan Joseph, CFA (415) 627-2925 First Call
Claude Hazan (415) 627-2845 DJIA: 8711
S&P 500: 1103
NMGSI: 119.5
Spotlight on: DRAM
Given the recent sale of Texas Instruments' DRAM operations to Micron, it
is timely to revisit trends in the DRAM market and the basis for our BUY
rating on Micron* (MU, $24-1/8)- now the world's leading producer of DRAMs with
a 20% market share.
o The DRAM market is currently in its third year of decline, which is
unprecedented: never before has it declined even two years in a row.
Shipments have fallen 42% from $25.1 billion at the peak in 1996 to $14.5
billion in 1998, according to the SIA. In this period, however, annual
bit demand has grown about 90%.
o In every cycle but one, a recovery year is characterized by solid double-
digit growth following the year of decline. Should pricing remain firm,
we believe the DRAM market could grow roughly 20% in 1999 while bit
growth should exceed 80%.
o The DRAM market is ultimately a rational market, and we believe an upturn
is inevitable. Over the past three years, the industry has burned about
$25 billion in free cash, by far the greatest cash drain in the history
of the business, and one that is not sustainable. Given that two-thirds
of the industry has financial backers that are illiquid, capital-spending
levels should see downward pressure for some time.
o Meanwhile, pricing in the spot market has firmed over the last two weeks
and some configurations have actually risen from extremely depressed
levels. Speculation of $1.00 16Mbs and $6.80 64Mbs has disappeared with
low-end quotes averaging $1.40 and $7.50, respectively.
o On a relative valuation basis, MU is at a low, trading at 0.93 times
price to sales and 0.32 times price to book, up very recently from
historical lows.
Hurts so bad. Looking at a chart of the historical cash flow for the
DRAM industry we may not be able to predict a bottom, but we can say there is
not enough liquidity in the system to sustain the current burn rate. Lower
levels of capital spending are likely for some time. By our own estimate, from
1996-1998, the industry will burn about $24 billion in free cash, and it will
likely continue to burn cash over the next two years. Two-thirds of the DRAM
industry has bad credits and cannot raise any substantial amount of capital. We
understand Korean banks are refusing to loan Korean DRAM makers more than 20%
of revenues. If true, capital spending from commercial loans will contribute
only about $800 million (20% of $4 billion in revenue) for capital spending in
1998, only 15% of previous totals.
Some positive short- and long-term pricing trends. There have recently
been both short and long-term positives in pricing.
o Short-term trends show flatter pricing. As we have noted in the past
two weeks, spot market DRAM prices in the past several weeks has
flattened out. This follows Korean DRAM makers' announced plans to cut
back production as much as 25% to raise prices in the spot market. There
is also some market speculation that Micron will also cut back
production, as it closes one of its newly acquired Texas Instruments
fabs.
o Long-term trends could be setting bottom. Prices have declined about 98%
in the last 2-1/2 years, and the initial improvements in yields and die
shrinks have not lowered cost enough to reduce the significant losses.
Indeed, by one estimate, the industry will lose $9 billion on $14.5
million in revenue. This is the reason for the cutbacks. But even with
the cutbacks, it appears that we have already seen the worst in per bit
price declines (see graph above), which tend to be cyclical. This is a
second derivative: it is not that DRAM prices are not declining, it is
merely that they are not declining quite as rapidly as before.
This is, after all, a rational market. Fortunately, all the research
we do says that the DRAM market remains rational. When prices decline, profits
decline and capital spending declines. And the opposite is true. Though this
may seem overly simplistic, what it does say is that the market is self-
correcting, in both directions. And that this is generally a closed loop cash
system, meaning contraction should take place until price declines stop.
Supply and demand in line by late this year, early next. Our bottom-up
forecast of output by leading DRAM makers suggests bit growth of supply should
exceed 80% this year. This is slightly higher than bit demand, which appears to
be about 74% currently, but rebounding. How rapidly the DRAM market, which we
believe is headed into a long-term rebound, will recover will be largely
dependent on whether unit growth in the PC market begins to reaccelerate.
Clearly, anecdote is building that the large PC OEMs have largely worked down
their excessive inventory levels and will begin ordering once again over the
next month, or so.
* NationsBanc Montgomery Securities LLC was manager or co-manager of a public
offering and/or has performed investment banking or other services for Micron
Technology in the last three years.
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