Micron Q3: Good Quarter, Bad Cash-Flow (Rating Downgrade)

seekingalpha2024-07-01

Micron beat revenue and earnings expectations in fiscal Q3 2024, but stock price slumped in extended-hours trading.Concerns over lower-than-expected cash flow and just in-line guidance for the current...

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FearX
2024-07-01
FearX
Disagreeing on the assessmeng. If the operating cash flow is still positive and in billion, it's not a worrying factor on miss because operating cashflow consist of many components. if its a negative operating cashflow then it's worrying. So I disagree with the downgrade rating if the cashflow just doesn't meet expectation.
- historyiong:
  Valid point
- FearX:
  Furthermore, rumours such as duplicating orders shouldn’t be referenced in this assessment when they are not facts.

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JHVEPhoto Investment Thesis Micron (NASDAQ:MU) released their fiscal Q3 2024 results on Wednesday, reporting revenue and earnings that beat the expectations held by analysts. However, the stock price slumped by 6.5% in extended-hours trading following this earnings release. I believe the primary reasons for this negative market reaction are the lower-than-expected cash flow and the just in-line guidance for the current quarter. As I have been closely following Micron's cash flow performance, I somewhat agree with the market’s reaction, and find these recent developments concerning. Operating cash flow for the quarter came in at $2.48 billion, falling short of the $3.24 billion estimate. This miss is especially important considering how important it is to consider cash flow when assessing a company like Micron's financial health and future growth. While Micron's strong revenue growth, jumping 82% year over year to $6.81 billion, driven by the growing AI demand in the data center sector, is encouraging, I believe the cash flow underperformance cannot be overlooked. As a result, I am downgrading my rating on Micron stock from a \"Strong Buy\" to a \"Buy.\" Despite my concerns, Micron's valuation still does remains attractive, with the stock trading at a discount to their peers. However, the cash flow miss and the potential risks associated with the company's dependence on key customers like Nvidia, I think warrant a more cautious approach. The rumored double or triple booking of demand by some customers adds an element of uncertainty to Micron's order book, as potential cancellations could impact the company's performance in the future. With this all in consideration, I remain bullish (though slightly less now) on Micron's long-term prospects. The company is well-positioned to benefit from the growing adoption of AI across various sectors, and their leadership in high-margin products like High Bandwidth Memory (HBM) provides a competitive edge. As Micron continues to navigate the dynamic memory market and address their cash flow challenges, I believe the stock still offers a compelling investment opportunity. Although the stock is no longer a strong buy for me (due to the concerns listed above), I still have confidence in their future, but now believe they are a buy vs. a strong buy. Why I Am Doing Follow-Up Coverage I last covered Micron earlier this month, to which I gave it a strong buy rating. My main reasoning for lowering the rating was the same then as it is now: cash flow. In my previous article I discussed how companies that reach positive cash flow are often more sustainable than companies that are just profitable. I believe cash flow is everything. Operating cash flow is an important part of this equation. In my previous article I mentioned how Micron’s price-to-cash flow ratio was significantly lower than the sector median, representing an upside potential of 30.45%. However, after earnings, management has shown cash flow falling short of estimates. As a very data driven analyst, this is something I have been focused extensively on. I do not think that this lower operating cash flow is concerning enough to move my stance to a hold (assuming this is a one-off quarter), however it is enough to move from a “strong buy” to a “buy.” The purpose of this piece is to not only explain my reasoning for this change in stance but also to be transparent with my readers and alert them as soon as my opinion changes. Earnings Review Micron just reported their results for the third quarter of the 2024 fiscal year, and I am overall impressed. These results demonstrated the company's strong position in the memory market and their ability to capitalize on the growing demand for AI-related products. The company's revenue for the quarter ended May 30, 2024, increased 82% year-over-year to $6.81 billion, surpassing the consensus estimate of $6.67 billion . Revenue was not the only metric that beat expectations, earnings per share came in at $0.62 compared to the anticipated $0.53. This remarkable revenue growth was largely attributed to the increasing adoption of AI across various industries. In fact, Micron noted that AI demand drove a significant 50% of their revenue growth in the data center segment. This highlights the company's successful strategy of focusing on high-margin, AI-related products such as High Bandwidth Memory (HBM) and data center SSDs. Micron's strong performance is even more impressive considering the stock's tremendous run-up this year. The company's shares have gained 54.12% year-to-date, reflecting investors' confidence in Micron's ability to benefit from the AI boom. However, as I previously mentioned the stock experienced a 6.5% drop in extended-hours trading following the earnings release. This drop was likely due to concerns over cash flow missing expectations and cautious guidance for the upcoming quarter. Despite these near-term challenges, I continue to believe Micron is well set up to capitalize on the growing AI opportunities within the memory market. The company's CEO, Sanjay Mehrotra, expressed his excitement about Micron’s future in a statement, stating: We are excited about the expanding AI-driven opportunities ahead, and are well positioned to deliver a substantial revenue record in fiscal 2025. -Seeking Alpha. For Micron's third quarter, their Non-GAAP gross margin was approximately 28%. This is an increase of over 8 percentage points sequentially. This improvement can be credited to higher pricing, favorable product mix, and cost reductions. As the company continues to put their focus towards high-value products and maintaining a leading position, I expect they will further expand on their gross margins in the coming quarters. While operating cash flow brought me concern, conservative guidance made some pause, and the post earnings report led to the stock experiencing a short-term setback, I still think long-term the prospects remain promising. My confidence stems from their continuation of innovation and catering to the growing demand for AI-related memory solutions. Management Commentary During Micron’s Q3 2024 earnings call, management provided what I believe to be valuable insights. CEO Sanjay Mehrotra emphasized the company's strong execution and their ability to capitalize on the growing demand for AI-related products. CEO Mehrotra emphasized the impact of AI on Micron's data center revenue growth, stating: In data center, rapidly growing AI demand enabled us to grow our revenue by over 50% on a sequential basis, and we grew share in high-margin AI-related product categories such as HBM, high-capacity DIMMs, and data center SSDs -Q3 earnings call. Considering AI demand will grow in the future, if Micron is able to continue to capitalize on this, I think revenue and share in high margin AI products will also continue to grow. With this, Mehrotra provided details on the strategies Micron took to improve their financial performance, stating, Micron drove robust price increases as industry supply-demand conditions continued to improve. This improved pricing, combined with our strengthening product mix, resulted in increased profitability across all our end markets -Q3 earnings call.  The CFO of Micron, Mark Murphy also noted: The consolidated gross margin for fiscal Q3 was approximately 28%, up over 8 percentage points sequentially driven primarily by higher pricing and helped by product mix and cost reductions -Q3 earnings call. Looking ahead, Mehrotra noted: As we look ahead to 2025, demand for AI PCs and AI smartphones and continued growth of AI in the data center creates a favorable setup that gives us confidence that we can deliver a substantial revenue record in fiscal 2025, with significantly improved profitability underpinned by our ongoing portfolio shift to higher-margin products -Q3 2024 earnings call.  This corroborates my belief from my pre-earnings preview that AI smartphone demand is going to be a key growth driver. Murphy also touched upon Micron's capital allocation strategy, stating: 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 -Q3 2024 earnings call.  Murphy then went on to state the company's expectations for capital expenditure in fiscal 2025, saying: 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 -Q3 2024 earnings call.  This clearly shows that Micron plans to invest heavily in their manufacturing to meet the growing demand for their products and maintain a competitive edge in the memory market. While I am pro-investment, I am keen to see the company maintain strong cash flow. Operating cash flow will need to keep up with this. Valuation Despite Micron’s strong revenue this quarter, the stock took a hit after the earnings report was released on June 26th. This was primarily due to concerns over lower-than-expected operating cash flow. Operating cash flow for the quarter was expected to hit $3.24 billion, but fell short by roughly 23.5%, coming in at $2.48 billion. The miss is a big deal for me, as I strongly believe cash flow is a crucial measure of assessing a company’s financial health and future growth potential. If we assume that operating cash flow for the next 3 fiscal quarters misses estimates by a similar percentage (23.5%), then this means 4 fiscal quarters of cash flow 23.5% below estimates. I am assuming a similar cash flow estimate conservatively to show how this could impact valuations. A decrease in cash flow would cause an increase in Micron's corresponding price-to-cash flow ratio (P/CF). Assuming all other factors remain constant, a 23.5% miss in cash flow would cause the current P/CF ratio to increase by approximately 30.8% (1 divided by 0.765, which is 1 minus the cash flow percentage miss). An increasing P/CF ratio suggests that the stock's upside potential will become more limited than previously expected. As of June 26, 2024, Micron's forward P/CF ratio stands at 17.36, 26.13% lower than the sector median of 23.49. However, after this earnings report, I estimate their P/CF ratio could reach roughly 22.7 if cash flow estimates miss by a similar amount going forward. If this were to occur, the upside potential would shrink to only 3.4% (22.7 vs. 23.49). This is down from my pre-earnings estimate of 30.45% upside. To be clear, I do not expect them to miss on cashflow like this in each sequential quarter going forward. But I am modeling this estimate to show how this could impact the valuation potential. In essence, if the company does not miss on cash flow estimates (or beats going forward to make up for the Q3 miss) then we could see upside closer to the 30.45% I originally estimated. If they miss (in a similar magnitude), then the upside may only be limited to 3.4%. I believe this gives investors a range of potential upside (3.4-30.45%) for them to evaluate based on their personal beliefs of where cash flow will go going forward. Risks While I am still optimistic on Micron Technology's long-term prospects, I do continue to focus on this operating cash flow miss. As I mentioned throughout this article, one of the primary risks currently facing Micron is related to their cash flow and the potential impact on their future performance. The continuation of producing strong financial results and capitalizing on growth potential are heavily dependent on the high demand for Micron’s memory solutions, especially from key customers in the AI industry, such as Nvidia. However, rumors of companies double or triple booking orders to secure a better expected value on their chip delivery has raised concerns about the sustainability of this demand of HBMs downstream from Nvidia. If these rumors are proven true, and a significant portion of these orders end up being canceled, it could have a huge effect on Micron's business. The company may find themself with excess inventory, reduced revenue, and lower-than-expected cash flows. This scenario could lead to further downward revisions in stock price. In light of this risk, I have decided to downgrade my price target and recommendation from a strong buy to a buy for Micron stock. While I still believe in the company's long-term potential, the near-term uncertainties surrounding their cash flow and the sustainability of AI-driven demand warrant a more conservative approach. Bottom Line  I believe there is no doubt Micron Technology's fiscal Q3 2024 results demonstrated their strong position in the memory market and their ability to capitalize on the growing demand for AI-related products. However, I am concerned over lower-than-expected cash flow and the potential risks associated with the sustainability of AI-driven demand. As I mentioned previously, as a data-driven analyst, cash flow is huge for me. Therefore, until there is greater clarity on Micron’s operating cash flow and the stability of their order book, I am changing my rating to a slightly more cautious stance. These factors have led me to downgrade my rating on Micron stock from a \"Strong Buy\" to a \"Buy.\"","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":322748086714552,"gmtCreate":1719826162987,"gmtModify":1720087572169,"author":{"id":"3585300524739374","authorId":"3585300524739374","name":"FearX","avatar":"https://static.laohu8.com/default-avatar.jpg","vip":1,"crmLevel":7,"crmLevelSwitch":0,"idStr":"3585300524739374","authorIdStr":"3585300524739374"},"htmlText":"Disagreeing on the assessmeng. If the operating cash flow is still positive and in billion, it's not a worrying factor on miss because operating cashflow consist of many components.&nbsp; if its a negative operating cashflow then it's worrying. So I disagree with the downgrade rating if the cashflow just doesn't meet expectation.","listText":"Disagreeing on the assessmeng. If the operating cash flow is still positive and in billion, it's not a worrying factor on miss because operating cashflow consist of many components.&nbsp; if its a negative operating cashflow then it's worrying. So I disagree with the downgrade rating if the cashflow just doesn't meet expectation.","text":"Disagreeing on the assessmeng. If the operating cash flow is still positive and in billion, it's not a worrying factor on miss because operating cashflow consist of many components. if its a negative operating cashflow then it's worrying. So I disagree with the downgrade rating if the cashflow just doesn't meet expectation.","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":84,"commentSize":2,"repostSize":3,"link":"https://ttm.financial/post/322748086714552","repostId":2448969326,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"comments":[{"id":323918535512112,"gmtCreate":1720088062258,"gmtModify":1720175943045,"authorId":3479274730958210,"author":{"id":3479274730958210,"idStr":"3479274730958210","authorId":3479274730958210,"name":"historyiong","avatar":"https://static.tigerbbs.com/673f24849e790c3aa318f19aa443d828","vip":8,"crmLevel":1,"crmLevelSwitch":0,"individualDisplayBadges":[]},"repliedAuthorId":0,"objectId":322748086714552,"type":1,"supId":0,"prevId":0,"content":"Valid point","text":"Valid point","html":"Valid point"},{"id":322749353832528,"gmtCreate":1719826704798,"gmtModify":1719826709772,"authorId":3585300524739374,"author":{"id":3585300524739374,"idStr":"3585300524739374","authorId":3585300524739374,"name":"FearX","avatar":"https://static.laohu8.com/default-avatar.jpg","vip":1,"crmLevel":7,"crmLevelSwitch":0,"individualDisplayBadges":[]},"repliedAuthorId":0,"objectId":322748086714552,"type":1,"supId":0,"prevId":0,"content":"<span class=\"s1\">Furthermore, rumours such as duplicating orders shouldn’t be referenced in this assessment when they are not facts.<span class=\"Apple-converted-space\"> </span></span>","text":"<span class=\"s1\">Furthermore, rumours such as duplicating orders shouldn’t be referenced in this assessment when they are not facts.<span class=\"Apple-converted-space\"> </span></span>","html":"<span class=\"s1\">Furthermore, rumours such as duplicating orders shouldn’t be referenced in this assessment when they are not facts.<span class=\"Apple-converted-space\"> </span></span>"}],"langContent":"EN"}],"isCommentEnd":false,"newsSizeData":{"likeSize":0,"commentSize":1,"repostSize":1,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.30.0","shortVersion":"4.30.0","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2448969326"}