Micron will release tomorrow with management expecting revenue to grow 89.5% YoY to $7.6 billion at the midpoint, an 8-point acceleration from last quarter. The stock is up 10% YTD at the time of writing, below the 80% returns in mid-June. The stock has given up much of its gains due to the potential fears of a temporary slowdown in the non-high-bandwidth memory market and concerns that Micron’s upside is limited due to contracted pricing for the next 6-8 quarters. We covered this here stating: “The blemish in the report is the commentary that HBM is sold out for calendar 2024 and 2025, with “pricing already contracted for the overwhelming majority of our 2025 supply.”
The slowdown in non-HBM memory is expected to be from smartphone and PC customers who “have built some inventory,” according to comments from Micron’s management team at the Deutsche Bank conference in late August. Taken out of context, it could be a dire comment yet the overall tone was bullish, citing the increase in non-HBM inventory is to protect smartphone and PC OEMs from higher pricing and tighter supply due to the outsized demand for AI-related HBM. Essentially, the message is that AI-related HBM is going to crowd out non-HBM in the supply chain.
The not-so-bullish commentary from the DB conference is more economic related as Micron stated: “We have shared before and as is well known in the broad industry reports that consumer retail channels, industrial, automotive tend to be relatively weaker right now, as well as China has some weakness too.” China is important to Micron making up 25% of its revenue. The company had stated earlier at a Keybanc conference: “In China, economic activity and consumer buying patterns are weak or uneven at best, depends on the market.”
Previous commentary in the earnings call and also during Keybanc’s conference hint that Micron is expecting several hundred million of HBM revenue in fiscal ’24, multibillion HBM revenue in fiscal 2025 and “have HBM consistent with our DRAM share at some point in calendar '25.” However, the discussions regarding Q1 in the DB conference were a lackluster, stating: “So when we look at all of these factors and all of these trends, when we look at our FQ1 we think our bit shipments will be somewhat flattish to slightly up in FQ1 versus FQ4.” This has caused some analysts to downgrade the stock as the expectation is non-HBM is weighing on HBM if we will see bit shipments “only slightly up.”
When the analysts downgraded the stock, some of them cited an oversupply of HBM. We see no evidence of an oversupply of HBM, and in fact, Micron has stated the opposite, stating they are seeing “robust demand trends” and “these trends of AI and the tight supply environment we see that continuing in 2025 as well. And that's why we say that, we will have substantial revenue record in 2025, and of course, robust profitability in 2025 as well versus 2024.”
We will see if Micron’s call has any changes in tone on HBM-related inventory; it’ll be important to carefully distinguish what is causing the underperformance on bit shipments as Micron is trading at an attractive valuation – nearly 50% lower than its historic average.
The trim today is not Micron-specific rather Knox has not been liking SMH’s recent price action. We are sending a clear message to our members that we aren’t buyers of AI semis at this moment as we think there will be opportunities to buy lower. We aren’t heavy sellers either, although we have a strategy where this could be the outcome over the next 30-60 days. Real wealth is made during drawdowns, not by perfectly timing a top. We’ve covered this extensively in our webinars and have a thought leadership article on the free side coming out by Knox next week on the topic, as well.
Revenue:
FQ4 revenue is expected to accelerate to 90.5% YoY growth to $7.64 billion and decelerate to 75% growth to $8.27 billion in Q1 FY2025.
Last quarter, revenue grew by 81.5% YoY to $6.81 billion, up from 57.7% in FQ2 due to strong AI demand. The company reported a record high data center revenue mix with 50% sequential data center revenue growth.
- DRAM revenue grew by 13% QoQ to $4.7 billion, helped by about a 20% price increase and offset by a decline in bit shipments in the mid-single digits.
- NAND revenue grew by 32% QoQ to $2.1 billion, helped by an increase in bit shipments in the high single digits and a price increase of about 20%. Management expects DRAM shipments to be flattish and NAND shipments to increase slightly in FQ4.
- Analysts expect FY2024 revenue to grow 63.3% YoY to $25.37 billion.
- FY2025 revenue is expected to grow 50.2% YoY to $38.10 billion and 16.3% to $44.30 billion in FY2026.
Margins
Margins experienced a steep cyclical low and now appears to have bottomed. In FQ2, the company achieved its goal of positive adjusted operating margin a quarter ahead of expectations, primarily helped by the recovery in DRAM and NAND pricing.
Management expects gross margin expansion to continue, helped by price and also higher-value products like HBM, high-capacity DIMMs (dual in-line memory modules), and SSDs. The guide for FQ4 is 34.5%.
Management reiterated the sequential improvement in adjusted gross margin for the November quarter as they said in the KeyBanc forum, “On gross margin, sequentially August to November quarter, we expect gross margins to be up around 200 — or up around a couple of hundred basis points, consistent with what we've said before.”
- FQ3 gross margin was 26.9%, up from (-17.8%) in the same period last year and 18.5% in FQ2. Management guide for FQ4 is 33.5%. The adjusted gross margin was 28.1%, up from (-16.1%) in the same period last year and 20% in FQ2.
The improvement in gross margin was due to higher pricing, product mix, and cost reductions.
- Operating margin was 10.6%, up from (-46.9%) in the same period last year and 3.3% in FQ2. Management guide for FQ4 is 17.8%. Adjusted operating margin was 13.8%, up from (-39.2%) in the same period last year and 3.5% in FQ2.
Management guide for FQ4 is 20.6%. The operating expenses were at the lower end of the guidance due to cost controls and operational efficiencies. Management expects operating expenses to increase sequentially in FQ4 “due to an increase in R&D program expenses and a nonrecurring Q3 asset sale gain contemplated in our Q3 guidance.”
- Net income was $332 million or 4.9% of revenue compared to a net loss of (-$1.9 billion) or (-50.5%) of revenue in the same period last year. Adjusted net income was $702 million or 10.3% of revenue compared to an adjusted net loss of (-$1.57 billion) or (-41.7%) of revenue in the same period last year.
EPS
FQ3 GAAP EPS came at $0.30 and beat estimates by 1.2%. Adjusted EPS was $0.62, up from an adjusted loss per share of (-$1.43) in the same period last year. The company beat adjusted EPS estimates by 17.3%, which was helped by higher prices, higher margin product mix, and cost controls.
- EPS guide for FQ4 is $0.61 at the midpoint and the adjusted EPS guide of $1.08 at the midpoint. Analysts expect adjusted EPS of $1.11 for FQ4 and $1.59 for FQ1.
- Analysts expect FY2024 adjusted EPS of $1.23, up from an adjusted loss per share of (-$4.45) for the FY2023.
- For FY2025 they expect adjusted EPS to grow 636% YoY to $9.04 and 34.5% YoY to $12.16 for FY2026.
Cash Flow and Balance Sheet
FQ3’s operating cash flow was $2.48 billion or 36.4% of revenue compared to $24 million or 0.60% of revenue in the same period last year and 20.9% of revenue in FQ2. The cash flows have improved with higher revenue and profitability.
FQ3 adjusted free cash flow was $425 million or 6.2% of revenue compared to (-$1.36B) or (-36.1%) of revenue in the same period last year and (-$29 million) or (-0.50%) of revenue in FQ2. Capex was $2.1 billion in FQ3 compared to $1.4 billion in the same period last year and $1.2 billion in FQ2.
Management expects positive adjusted free cash flow in FQ4 despite a capex of about $3.0 billion. Capex would be $8.0 billion in FY2024, up from $7.0 billion in FY2023.
Management expects capex to rise around 35% of FY2025 revenue, i.e., comes to about $13 billion and the company is able to support it due to higher profitability. Mark Murphy, CFO, said in the FQ3 earnings call, “Record revenue and significantly improved profitability in fiscal 2025 will help support average quarterly CapEx in fiscal 2025 to be meaningfully above the fiscal Q4 2024 level of $3 billion. We expect CapEx around mid-30%s range of revenue for fiscal 2025, which will support HBM assembly and test equipment, fab and back-end facility construction, as well as technology transition investment to support demand growth.
As noted earlier, half or more of the expected CapEx increase in fiscal 2025 will be to support U.S. greenfield fab construction. As we have noted in the past, the CHIPS grants, ITC, and state incentives offset a significant portion of the U.S. fab CapEx investments.”
- Inventory was $8.5 billion or 155 days compared to $8.4 billion or 160 days of inventory in FQ2. Management expects days of inventory to decline in FY2025. (This also runs counter to what some analysts downgrades are stating, which is there’s an oversupply when management comments point to the opposite).
- Cash and investments were $9.22 billion and debt of $13.258 billion compared to $9.7 billion and $13.7 billion in FQ2. In FQ3, the company repaid $650 million in debt and paid $128 million in dividends. The company had also announced in early August that they might resume the stock repurchase program.
Business Units
Compute and Networking Business Unit (CNBU) grew by 18% QoQ and 85% YoY to $2.57 billion. This was an acceleration from 59% in FQ2.
DRAM data center revenue more than doubled year-over-year. We foresee this segment being strong yet there could be potential weakness in client-related compute.
Mobile Business Unit (MBU) grew by 94% YoY and down (-1%) sequentially to $1.59 billion due to a planned volume decline, which was partially offset by improved pricing. Look for potential weakness here given comments that the oversupply maybe coming from mobile and PCs.
Embedded Business Unit (EBU) grew by 42% YoY and 16% sequentially to $1.29 billion helped by record revenue in automotive. Look for weakness here given commentary about automotive, industrial and consumer-related end markets.
Storage Business Unit (SBU) revenue grew by 116% YoY and 50% sequentially to $1.35 billion with growth in all end markets. The company achieved record data center SSD revenue, which nearly doubled sequentially. There could be potential weakness in the client storage segment depending on PC demand.
Other noteworthy points to watch
HBM Revenue
The company reported HBM revenue of over $100 million in FQ3 and expects to generate several hundreds in FY2024 and multiple billions in FY2025. They also expect the HBM market share to match the overall DRAM market share sometime in CY2025, which they mention is in the low 20s. UBS expects HBM revenue to be $5.61 billion in FY2025 from the expected $603 million in FY2024.expects HBM revenue to be $5.61 billion in FY2025 from the expected $603 million in FY2024. Management said HBM revenue is accretive to FQ3 margins and expects this trend to continue.
HBM and NAND CAGRs
HBM’s bit growth CAGR is expected to remain strong and be above 50% for the next few years.
“Well, as we have said before, that we see the CAGR for HBM growth — in terms of bit growth CAGR to be well above 50% over the next few years. So certainly, HBM is a strong growth driver. And again, as we increase our mix of HBM going forward, it will, of course, be continuing to be accretive to our financial performance, including margins. And we are pleased that with the strong performance that we have we are sold out for '25 as well with overwhelming part of our output already committed in terms of pricing.”
During the Q&A, it was pointed out that the forecast for NAND CAGR growth was lowered from “the low 20s” to a new forecast of “growth in the high teens.” Management’s response was the following:
“And I'll also tell you that we basically revise the base here for the CAGR that we used. So this time, the CAGR that we used, we use the base year of 2023. And in 2023, as you know, we had bit demand growth in NAND that was higher, meaningfully higher than the CAGR. So that, of course, the larger base of 2023, just somewhat changed our outlook on the overall CAGR.”
AI PCs and Smartphones
The company expects to benefit from the AI PCs and smartphones. They expect AI PCs to have 40% to 80% more DRAM content than today’s PCs. Similarly, smartphones that are AI enabled will have about 50% to 100% more content compared to phones released last year. In the near-term, management has stated there could be an oversupply. We expect there to be more questions on the call about this comment from the DB conference. “PC and smartphone customers have built additional inventories due to the rising price trajectory, the anticipated growth in AI PCs and AI smartphones, as well as the expectation of tight supply as an increasing portion of DRAM and NAND output is dedicated to meeting growing data center demand.” There are additional China-related concerns for mobile and PCs.
Valuation
On the top line, Micron is trading above it’s historic valuation at 4.85 compared to its five-year P/S ratio is 3.58. Notably, since the FY ends in August, the P/S ratio will be adjusted post-results and is trading at a 2.7 forward PS. The forward PS is the one that will reflect the valuation post-results.
On the bottom line, the forward PE Ratio of 10.5 will take effect post-results and is about 20% to 30% lower than the 3-year and 5-year median. These valuations are tricky because AI stocks are being re-rated. For example, Nvidia and AMD are trading about 50% lower than their averages, and yet are struggling to breakout. We think it’s important to weigh what the stocks have been trading at since the AI boom, or about early 2023. Micron has been trading considerably higher since the AI boom and we continue to watch the stock for the right entry over the next few months.
Conclusion
Micron is setting up to be an excellent buy over the next few months, yet we continue to watch the horizon to buy AI stocks at lower prices. Micron is perhaps the more complicated AI semi to time as it’s trading at an attractive valuation yet it’s also a bellwether of sorts for the economy. There could be a scenario where any AI bullishness is overshadowed by consumer-facing segments. Notably, the margins are expected to continue improving in FY2025 and we foresee Micron being more defensible than others when it comes to economic headwinds, albeit less defensible should we see China-related headwinds.
We are patient. We have time on our side. We will participate if Micron does well tomorrow, yet we also trimmed should Micron not do well tomorrow. Look for the I/O Fund to lean into defensibility while acknowledging inning one from AI (which started in 2023) has been a crazy-good run and our goal is to load up for inning number two in the coming months.
Royston Roche and Beth Kindig, Equity Analysts at the I/O Fund, contributed to this article.
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