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Micron (MU) - Get Report remains out of favor as investors shy away from its stock which has been incredibly volatile.

However, its underlying performance continues to point in the correct direction, with its key markets -- data servers and smartphones -- showing strong tailwinds.

Once its operations move out of the slump they've been in and its free cash flow returns to former highs set in 2018 of $9 billion, even with a 10x multiple to free cash flow would see Micron being valued at close to $90 billion. That would represent at least 50% upside potential.

Micron sells memory chips, which are commoditized products. They sell NAND memory and DRAM memory. NAND memory is the most commoditized memory type and has the poorest margin profile. DRAM has significantly better margins and makes up approximately 66% of total revenue, with only three global players, Micron being one of them.

In essence, DRAM memory is a high performance, high-speed data retrieval memory, and is aimed mostly at cloud server, enterprise, smartphone and networking markets.

The other memory type Micron sells is NAND, which is a low-cost storage solution, such as home hard drives. This is a smaller part of Micron and less meaningful to the overall thesis here.

Micron sells into these key verticals: approximately 27% towards servers, 25% to smartphones,20% into PCs, and20% towards automotive uses (this includes industrials and other applications).

Thus, even if servers are performing strongly at present until smartphone and industrials sales restart in earnest as the economy reopens, this will continue to slightly offset its performance in servers and cloud solutions.

Indeed, previously a large portion of Micron's chips used to go into smartphones. However, currently, with Apple AAPLpossibly deferring its new iPhone on the back of supply disruptions, this has a knock-on effect on many of its customers, including Micron.

For its part, Micron has stated that it has been quick to pivot into server sales, but its mobile unit continues to drag down its performance.

Micron recently pre-announced its results and stated that its upcoming Q3 2020 results to be reported at the end of this month are going to come out strongly.

In fact, compared to its guidance and its Q2 2020 results, even the bottom end of its pre-announced earnings are going to be higher than the top-end of its previous estimates.

Specifically, Micron now estimates that its non-GAAP EPS is going to be $0.75 to $0.80 compared with $0.70 of non-GAAP EPS (the top end of its previous guidance).

Even though some companies are thriving in our work-from-home economy, there are many that are struggling during this global contraction. Micron is not only meeting its guidance, but also raising its estimates and is still cheaply valued.

On the one hand, Micron is a cyclical stock. I argue, though, that its cycles are going to be substantially less severe going ahead, particularly over the very near term (12 months), than they were back in 2016 and throughout other memory slumps.

Nevertheless, to a huge extent, Micron sells a commoditized product, and if supply from competitors irrationally floods the market, there's little that can be done to overcome that environment.

Consequently, these points together somewhat depress Micron's multiple from getting too extended.

On the other hand, the demand for memory in servers, cloud, 5G, machine learning, and autonomous vehicles is only going to increase. Thus, there is a very strong secular tailwind to Micron's operations.

Also, during this downturn, Micron is still expected to be profitable, which is a vast improvement compared to the last downturn in 2016.

Taken together, given the right environment, Micron could well return to making $9 billion of free cash flow. Thus, without huge expectations, Micron's stock could trade at 10x to free cash flow (not earnings, but clean free cash flow, which is valued significantly higher).

Micron reports its results in approximately one month's time. By that time, the company's visibility should be significantly better than it was when it last reported its results.

We know that as conditions become more favorable, Micron is able to rapidly ramp up sales, which given Micron's operating leverage, means that getting closer to historically high free cash flow will be easier in the new normal than it was before.

See the article here:
Micron Has the Potential to Rise 50% From Here - TheStreet