ALL MU INVESTORS READ THIS. GRUNTAL STRONG BUY UPDATE>>>>>>>>>>>
Gruntal & Co., L.L.C. Micron Technology
Semiconductors & Electronics Strong Buy Update
Release Date: May 26, 1999 30-Year T-Bond: 5.75%Micron Technology
(MU – NYSE – $34.50)
Rating: Strong Buy
12-Month Price Target: $100 Investor Suitability: Aggressive Growth
52-Week Range: $80.56– $20.06 Price/Sales LTM: 3.0x
Average Daily Volume: 3.558 Mil Cash/Share: $6.55
Shares Outstanding (Mil.): 273.0 Book Value/Share: $14.45 Year EPS P/E
Float (Mil.): 102.70 Price-to-Book: 2.39x 08/98A ($1.11) NA
Insider Holdings: 13% Debt-to-Capital: 41.0% 08/99E $0.12 287.5x
Institutional Ownership: 55% Expected 5 Yr. CAGR: 18.0% 08/00E $3.00 11.5x
Dividend/Yield NA
Market Capitalization (Bil.): $9.42 Fiscal Year End: Aug. 31
New DRAM Cycle Gaining Momentum; Reiterate Strong Buy
Despite softness in the DRAM spot market, a new cycle with different dynamics seems to be gaining momentum. The last
three years have been one of the worst and longest downturns in the volatile history of the DRAM market. The last six months
were characterized by stop-and-go high hopes coupled with painful corrections. After a period of stability in the spot market,
the balance collapsed during the last two months. We believe that this downward slide in prices is transitional and should not be
viewed as the beginning of another crash in the DRAM market. More importantly, the recent price slide should not distract
investors from focusing on structural changes in the industry, including the fact that Micron is rapidly becoming the largest
supplier and lowest-cost producer in the DRAM market worldwide. This new position should promote powerful earnings
leverage as the new cycle unfolds.
The current excess supply should be a short-term phenomenon, since it was triggered by yield enhancement and improved utilization following a period of production cutbacks during 1998. The increase in supply from so-called soft capacity is not coming from new fabs or a massive rush to invest but from fabs from previous
capital-spending binges that were underutilized or idle during the downturn.
Historically, increased output from productivity enhancement is fairly limited relative to the floods triggered by new fabs coming on stream. The increased supply
from manufacturing efficiencies came during a seasonally soft period; despite this, the market was able to absorb the additional quantities, which resulted in an
exacerbated impact on pricing. The first half of the year tends to be slower, and we believe that spot market prices will stabilize during the second half. We believe that prices will decline at an orderly rate, in line with the memory learning curve, rather
than anything similar to the sudden 30% drop in less than 45 days which just occurred. The case for a structural reduction in DRAM supplies over the next two years
remains in place. Industry capital spending peaked in 1996, was reduced in 1997, was slashed in 1998, and should grow anemically in 1999. This is the most compelling evidence supporting our argument that DRAM supply will be curtailed during the next two years. With demand growing at a rapid pace, supply/demand should eventually balance out, giving the industry a period of prosperity. Overall
demand continues to be on a fast track after growing more than 85% during 1998.
The PC industry, which accounts for over 70% of DRAM consumption, is
experiencing strong unit demand driven by continuously cheaper PCs and dramaticincreases in the average memory configuration for both desktop and notebook computers. On top of the unit explosion for PCs is the Internet, the growth of which is driving demand for servers loaded with ever larger DRAM memory. We believe
that the megabit (Mb) demand curve is shifting to a much higher slope as a result of the large abundance of cheap memory during the last three years. Micron is aggressively consolidating and expanding its DRAM market share through conversion of Texas Instruments' (TXN-NYSE-$106.62-Strong Buy) facilities and by upgrading its Boise operations. Micron, in our view, captured the number-one spot in the DRAM market during the first quarter of calendar 1999. The company's
continued focus on lowering its cost structure should position it as a formidable opponent to other suppliers. We believe that MU has the lowest cost in the industry and that, as it drives to capture increased volumes, its cost will continue to drop, thus enhancing earnings leverage. We believe that this business model will continue to pressure marginal DRAM suppliers and promote further consolidation in the memory industry.
MU stock is currently trading at 11.5 times our fiscal (August) 2000 EPS estimate of $3.00, which represents a 36% discount to the company's projected long-term growth rate of 18%. We arrive at our $100 price target by applying a P/E multiple of
33.3 this multiple is justified given that Micron's DRAM market share is expected to increase to 23% from 20% during the next six months and that the company is the industry's lowest-cost producer. In addition, the company successfully shifted almost all of its manufacturing starts to 0.21-micron technology with its lower-cost
0.18 micron gaining momentum. We believe that DRAM prices will stabilize due to seasonal improvements in demand, the decrease of incremental supply, and the technology shift expected in the second half. Furthermore, Micron's balance sheet is strong and cash rich, totaling approximately $1.8 billion or $6.55 per
share. We expect the stock to remain under pressure until the market fully realizes the significance of being in front of a rising memory business cycle. Furthermore,
we believe that declining prices will serve as a silver lining long term as lower-tier suppliers will be forced to exit the market, thus promoting further industry
consolidation. We would urge aggressive investors to use any weakness as a buying opportunity.
Although Micron has declined from its $80.00 high on February 4, 1999, total money flow has demonstrated a strong bullish divergence. This suggests to us that larger investors are buying the stock at the offer price while smaller investors are selling at
the bid price.
Over the last three years, investors have obsessed about spot market pricing, making it the focal point for their entire thesis on the DRAM market. Spot market prices indicate the balance of supply and demand, and while they are an accurate reflection
of supply and demand balance at a given point of time, they are by no means a barometer of or even a discounting mechanism for future trends. We believe that the investor mindset perceives spot prices as similar to stock prices, with lower prices indicating future problems. This view is not only erroneous but also dangerous
during inflection points, when the preceding spot prices are totally misleading.
During 1995, the massive shortage that triggered a spot market frenzy did not foretell the catastrophic events of the next three years. In the summer of 1998, when the spot market was collapsing to seemingly unbelievable low levels, applying the forward spot price mechanism would have caused investors to miss Micron's biggest stock
move in more than three years. During the second (February) fiscal quarter of 1999, Micron increased its megabit output 75% from the previous quarter's level. The expansion of megabits shipped was better than our optimistic forecast of 50% and far above prior guidance of 20%-25% given at the end of 1998. Despite the added
supply, the market was able to absorb this capacity in a seasonally slower quarter while Micron capitalized on gaining market share.
This type of focus may be accurate for immediate events, but it definitely eliminates
the bigger picture of what is likely to happen over the next two to three years.
When the May quarter started, 64-meg DRAM spot prices were above $9.00, but as the quarter progressed the spot market collapsed, with the prices going as low as $5.50. DRAM prices continued to decline as the so-called soft capacity came on stream during the seasonally weak first half, with the major suppliers aggressively
expanding their market share and continuing to pressure weaker suppliers. More importantly, some of the capacity which idled during the downturn came on stream during the fourth quarter of calendar 1998 as stable pricing prevailed and attracted suppliers. The most aggressive suppliers were Siemens A.G. (Germany) and LG
Semiconductor (Korea). The latter's Fab 9 was quickly ramped following a labor-strike settlement. This stepped-up output does not compare to the output in 1996-
1997, when new megafabs were turning out new capacity and flooding the
marketplace with seemingly endless supply. This is not an issue in today's marketplace because semiconductor capital spending was slashed 9.9% in 1997 and 25.3% in 1998.
Our EPS estimate for the third (May) fiscal quarter, $0.10, is based on the assumption that MU will increase Mb shipment approximately 22% sequentially, benefiting from production increases and inventory from the previous quarter. Last quarter, Micron dramatically increased its megabit output more than 75% on a sequential basis. We are also applying an average selling price (ASP) of $7.00,
yielding EPS flat with the previous quarter as gains in volume are erased by the price decline. We are using a $7.00 ASP since it is a blended price for the total shipped in
the quarter. Since the quarter started with a $9.00 price and ended at $5.50, a $7.00 blended price is a reasonable assumption.
We believe that the current price weakness is transitional and a result of (1) capacity underutilized during 1998 coming back on stream and (2) enhanced manufacturing
yields. Although the added volume is overwhelming the market, it is occurring during a seasonally weak period and cannot be compared with the impact of new fabs. We believe that, as the second half rolls in, rising demand should absorb the
current supply. We expect negligible capital spending this year; after capital-spending cuts in the previous two years, this should promote a supply shortage in 2000 and 2001. The current weak prices and their impact on marginal suppliers should ensure that capital spending is spartan in the near future.
In our view, the Asian financial meltdown will have a dramatic impact on the DRAM market's competitive landscape. DRAM production is probably the most capital-intensive product area in the semiconductor industry. New generations of DRAMs
are more bits in a smaller space—no fancy functionality, just denser and faster chips. Accordingly, suppliers of DRAMs have to push the hardest on process technology to obtain the increased density and speed. Next-generation memory chips are always the
catalysts for newer equipment upgrades. Moreover, with intense pricing
competition, the need to drive manufacturing becomes more intensified. Previously, the Koreans and the Japanese had access to cheap capital, which was utilized as a
major competitive weapon to drive their market share in memory with aggressive pricing. We believe that this game is over, at least for the upcoming cycle.
During the mid-1980s, Japanese suppliers poured enormous amounts of capital into
memory manufacturing. The Japanese cost of capital at that time was extremely low. Meanwhile, U.S. suppliers were still struggling with expensive capital from the debt market and with limited access to equity finance. This was primarily a result of a
severe industry downturn during which almost every semiconductor supplier lost money. This resulted in Japan capturing the biggest market share of the memory market, while every U.S. supplier of DRAMs, with the exception of Micron and Texas Instruments, exited the market after massive losses. In the early 1990s, the
Japanese financial systems started to weaken, and this reduced the ability of Japanese suppliers to utilize cheap capital. Their memory market share peaked, and the pricing environment became more predictable.
The 1990s also marked the emergence of the Koreans as big spenders on DRAM production. The Koreans utilized their own financial system to pour billions of dollars into memory manufacturing facilities. The extremely low cost of capital for the Koreans led to major gains in their memory market share, much like the Japanese
in the prior cycle. Eventually, the Koreans became the largest suppliers of DRAMs, which provoked another bloodbath in memory pricing. This prompted Texas Instruments to exit memory, thus making Micron Technology the only U.S. supplier
remaining in the DRAM industry.
We believe that the current pressure on DRAM pricing is driving consolidation around the major suppliers. Several marginal players are exiting the market, while others are reducing their supply commitments. By the end of 1999, the top three
DRAM suppliers should account for 60% of the market, resulting in increased price stability. Micron views Samsung as its strongest competitor as other Korean competitors remain in turmoil. Hyundai/LG Semiconductor are struggling with all kinds of issues relating to their merger and finances; more importantly, their capacity
is largely 0.30 micron and clearly not cost effective. We believe that the Japanese are reducing their commitment to DRAMs, while International Business Machines (IBM-NYSE-$221.18-Hold) is almost entirely out of the market. Furthermore,
Siemens is struggling with spinning out from its parent, but it was very aggressive in pricing during the first quarter as it moved swiftly to reduce inventory and fill current
capacity. Micron is aggressively lobbying to put more pressure on its foreign competitors. For
example, the Export Import Bank stopped guaranteeing bank loans for equipment purchases by foreign suppliers who are dumping products. Additionally, efforts to use International Monetary Fund (IMF) money to bail out the Korean semiconductor industry have been prohibited, and enforcement is in full force. Although many of
the Korean companies are using creative accounting to cover their tracks, the U.S. government is on the alert. We believe that Micron will keep pressure on the marketplace to insure continued consolidation in the memory group. Because it takes a minimum of 18 months to bring new semiconductor facilities to
the market, capital investment decisions made now will impact the industry sometime in 2000 or 2001. Accordingly, investments made in 1996 and 1997 are impacting the memory industry today. Industry capital spending took off in 1994 and 1995 before peaking in 1996. The decline in capital spending started in 1997 and collapsed further in 1998, and we expect 1999 to be another anemic year for
semiconductor spending. During the last three years of excess capacity and aggressive pricing, DRAM suppliers have flooded the market. The industry moved from 4Mb to 16Mb to 64Mb with incredible ease as the suppliers raced to find new-generation chips to squeeze additional profits. Unlike other commodities, DRAM
capacity is perishable. The longer it takes to fill the capacity, the less valuable it becomes as most DRAM capacity becomes obsolete within three years. To remain competitive in the DRAM market, suppliers need to be on the cutting edge with manufacturing. Leading-edge capacity is designed not only for delivering the fastest
and densest chips but also for attaining the lowest cost. Older capacity is not cost effective.
We believe that the capacity binge of 1995 and 1996 caused the prolonged downturn, just as the capital-pending cuts of 1997 and 1998 should have set the stage for the current upturn. DRAM capital spending peaked in 1995 at $22.5 billion and decreased to a feeble $6.0 billion in 1998. In our view, the cast has been made for
the next two years. Moreover, worldwide semiconductor capital spending declined almost 10.0% in 1997 and over 25.0% in 1998, and current forecasts remain weak,
with no growth in sight until 2000. We believe that this is not the thesis to support prolonged oversupply in memory and lower spot prices; rather, we expect a shortage Current up cycle consolidating
around major DRAM suppliers as marginal players remain in financial
turmoil
The die is cast for a rising memory
business cycle
Early on, Micron Technology recognized that to win in a commodity market such as DRAMs, the company needed to concentrate on cost. Management's philosophy revolves around the endless pursuit of lower costs—essentially, shrinks and more shrinks to improve yield. The ever-shrinking die and the ever-expanding wafer are the road to utopia for Micron. This manufacturing philosophy enables the company
to control losses during hard times and leverage profits during upturns. The transition to 0.18 micron is under way in Boise, while other facilities have been converted to 0.21 micron. Management indicated that the transition to 0.18 micron should be painless since the conversion to the 0.21-micron process was specifically
designed with the future of 0.18 transition in mind. Currently, Micron has over 15% of its wafer starts operating in 0.18-process technology, and we expect production to
shift to this version by year-end. This rapid migration to smaller die sizes should drive the company's unit costs down while increasing its unit output and capturing additional market share. We believe that this will position Micron to realize solid earnings momentum and profitability.
Micron invented ways to improve yields by squeezing more out of each wafer and, more importantly, by upgrading and converting to new manufacturing processes without building new fabs for every conversion. This is a different approach than in
Asia, where easy money financed the construction of new fabs during the up cycle.
We believe that Micron's experience in leveraging manufacturing and its focus on costs will continue to give the company a competitive edge over other suppliers.
Micron's cost structure is the lowest in the industry. The company continues to aggressively shrink its DRAMs, utilize the fabs from TXN, and implement other manufacturing efficiencies related to test and assembly. Moreover, Micron will be the only major DRAM supplier with no royalty payments to TXN. The acquisition
of TXN's facilities should result in a significantly lower cost of capital for Micron since the transaction was at an excellent price relative to the production capacity acquired. Management's objective of bringing cost for 64 Mb to below $6.00 was
achieved by the end of December 1998. Furthermore, we expect Micron to reduce its cost for 64 Mb to below $4.00 by the end of 1999. We believe that the widespread concern over falling DRAM prices is justified, but stable prices or even prices that
decline at a slower rate than in prior years should generate strong profits and result in increased earnings leverage from Micron.
Memory: It all comes down to cost
Historically, Micron's strategy was not to be the first supplier to head toward a new generation but rather to move to a new generation after volume built up, aggressively
managing its cost to generate stronger profits. Micron was always one of many suppliers, but never one of the leaders. Micron tended to stay with a particular generation longer than others and use it as a cash cow before transitioning to the next
generation. As the company's market share expanded and its industry status continued to rise, Micron shifted its strategy to fit a new role. The company was an early adopter of the 64-Mb eight-inch wafers and the transition to 0.21 micron or less, and it developed high-speed Rambus (RMBS-NASDAQ-$74.75-Not Rated) and
Synclink technology. We believe that the DRAM market is shifting to a new technology standard that will position the industry for growth ahead. Higher-speed specifications, including PC-133, will not only require increased DRAM performance but also command a price premium. The rollouts for these higher-performance DRAM transitions are likely to occur in the second half of calendar 1999.
From trailing edge to leading edge
We expect Micron to move rapidly to leading-edge technology in its development while maintaining its profit focus by transitioning its volume when it believes that optimum profits can be derived by the next generation. Additionally, as the DRAM field continues to consolidate, several vendors will not have the capability or the
capital to support the newer technology, and this will clearly be an advantage for Micron. We also expect to see higher-memory output start shipping to the server and workstation markets, which would imply a price premium relative to 64 Mb. These upgrades in technology will incorporate a higher-blended ASP for Micron in the second half of calendar 1999 that should promote solid earnings and revenues.
Micron Technology manufactures and markets 16-Mb and 64-Mb DRAM components in EDO and Synchronous architectures in various widths. Additionally, the company is developing Direct RDRAM products and other high-speed technologies, such as faster applications, to address the segmentation of the DRAM market. Micron's products
serve the PC, PC-peripheral, consumer electronics, telecommunications, networking, and graphics industries. Micron's manufacturing facilities are located around the world, and the company became publicly held in June 1984. The company's last 12
months' sales total over $3.1 billion.
New DRAM Cycle Gaining Momentum; Reiterate Strong Buy |
