A Silver Lining In Micron’s Kitchen-Sink Guidance (NASDAQ:MU)

There’s nothing as onerous as a down cycle in a commodity business like DRAM. Inventory piles up, customers cut orders, prices drop, and everyone suffers. To get a sense of how that feels, look no further than Micron Technology, Inc. (NASDAQ:MU), one of the world’s largest memory chipmakers that just provided an industry-leading guidance of C3Q22 revenue at 21% below Street consensus.

Granted, Micron’s C2Q22/F3Q22 results were largely in line with estimates. Though revenue of $8.6 billion (+15% YoY) and gross margin of 47.4% were slightly below consensus, operating margin of 36% was inline and adjusted EPS of $2.59 was a nice beat against Street’s $2.43. Additionally, the company generated $1.3 billion of free cash flow, spent $981 million on share buybacks, and intended to buy more shares at current levels with $12 billion of cash on the balance sheet.

Despite solid C2Q22 results, management provided an underwhelming outlook for C3Q22 as demand for smartphones and PCs turns out to be worse than expected. Specifically, PC unit sales for 2022 are to decline by 10% YoY (vs. flat prior/30 million units lower) and smartphone units are to decline by mid-single-digit (vs. flat prior/130 million units lower).

C3Q22/F4Q22 Guidance

• Revenue of $7.2 billion +/- $400 million vs. $9.14 billion consensus.
• Gross margin of 42.5% vs. 47.9% consensus.
• Operating margin of 27.9% vs. 37.1% consensus.
• Adj. EPS of $1.63 +/- $0.2 vs. $2.57 consensus.

Naturally, shares dropped the day after Micron’s earnings release on 6/30 but have more than recouped the loss since. This shows that investors have been anticipating a kitchen-sink guide down from management for quite some time. A slowdown in the smartphone and PC market in 2022 should not come as a surprise after a strong 2021 when demand skyrocketed under the pandemic. Of course, the impact of the Russia/Ukraine war, Covid-19 lockdowns in China, and inflation have all contributed to slower demand.

Due to a weaker 2H22 outlook, Micron also expects 2022 industry bit demand to grow at below the long-term CAGRs of 15%-19% for DRAM and 27%-29% for NAND. In consumer-driven end markets, smartphones and PCs will likely see more inventory adjustments in the second half of the year. Though demand in data center is expected to remain strong driven by continued cloud Capex growth, it’s worth noting that PCs and smartphones still make up roughly 50% of worldwide memory and storage demand in terms of bits.

While things are likely to get ugly in the next two quarters, the silver lining here is that Micron management is reacting rather quickly by cutting WFE (wafer front end) Capex in FY23 starting in September 2022 and will be using existing inventory to address demand going forward. From a pricing perspective, we can see that the company is clearly prioritizing profitability over market share, a mentality that historically didn’t quite fit the memory industry in general.

We intend to maintain pricing discipline and walk away from business which doesn’t meet our pricing objectives. – FY3Q22 Earnings Call

Overall, Micron is an early mover in recognizing changing industry fundamentals by rightsizing its bit supply to reconcile with declining demand. Management also expects a 30% QoQ decline in sales from China and a resulting 10% revenue impact in C3Q22/F4Q22. Taken all together, Street estimates have come down dramatically, with FY23 EPS revised from $10.7 pre-C2Q22-earnings to $6.8 post-earnings, bringing the forward P/E multiple from 5.3x to 8.3x.

Longer-term, the demand outlook for memory remains strong, driven by ongoing investments in data center, auto and industrial. Micron expects its revenue mix to shift from 55% in consumer markets (smartphones & PCs) and 45% in higher growth areas (data center, auto, graphics, industrial and networking) in 2021 to 38% and 62% in 2025, respectively. As the company gradually shifts towards areas with secular tailwinds, demand cyclicality should improve as a result.

If history is a guide, management believes inventory adjustments will take 2 quarters to work through. The situation is kind of similar to that of Target (TGT) (analysis here) and Walmart (WMT) (here), where both big box retailers are dealing with elevated discretionary inventory that will likely take 1-2 quarters to normalize. Coming back to the semiconductor space, investors should also be aware that estimates for companies exposed to the consumer sector are likely still too optimistic, and that markets may also be more inclined to wait for more kitchen-sink guidance as companies report earnings in the near future.

Nevertheless, I view Micron’s guide down as a positive step in the right direction in light of today’s market fundamentals. Management has embraced the right mindset to manage the business defensively to prioritize profits over market share. While many investors may think the stock has bottomed at current levels following somewhat positive price actions post-earnings, I would prefer to stay on the conservative end and monitor the situation for any further macro-driven deterioration on the demand side of the equation.