Micron's (NASDAQ:MU) stock has turned course, dropping below a key $40 level fast. Something's up. They report earnings March 20. With the news of DRAM prices getting worse, somebody's selling. Let's walk though some data.
Let's Talk DRAM Prices
DRAM made up 68% of the company's revenues last quarter. This is the single most important driver to the company's earnings.
In January DRAM prices were expected to drop by 20% in Q1 from Q4.
Since then, more recently, DRAM prices were reported to be down by as much as 30% in Q1 from Q4. That's reported to be the largest drop in DRAM prices since 2011.
What's Going On?
Accelerating DRAM prices to the downside don't appear to match Micron's expectations for an improving environment later in the year.
Dropping prices imply a fall off in demand. Keep in mind DRAM makers have been cutting capacity so the main driver now for prices likely has to be a fall off in demand. Lower supply should act to support prices, yet it's not.
Micron said the following on their last earnings call,
"Looking beyond fiscal Q3, as we enter the second half of calendar 2019, we expect a healthier demand environment alongside an improved industry supply picture, which should contribute to improved financial performance."
We're not yet at the back half but we're one quarter away. You'd hope that Micron has some confirmation that the back half can pick up as they had previously been expecting publicly.
But the accelerated drop in DRAM prices might tell you otherwise.
Micron has called out multiple reasons why they had been seeing weakness. One, they said inventory had built up at customers. Two, that end-demand in mobile has been weaker, as we've seen with Apple's (NASDAQ:AAPL) reduced guidance.
But listen to how important the mobile market is for memory. This was Micron speaking at recent investor conference.
"And that weak first half is largely driven by the confluence of factors I mentioned of which the inventory correction is a pretty large factor and certainly there is an impact coming from weakness in mobile. There is no doubt mobile is a very large part of both DRAM and NAND consumption. It's almost 40% of the demand in the market."
Mobile makes up "almost 40%" of memory demand.
Apple called out weaker demand for iPhones on their last earnings call:
"One of those factors, weak macro conditions in some emerging markets was significantly more severe than we originally foresaw, especially in Greater China. As our letter noted, that challenge was compounded by quarterly iPhone upgrades that were lower than we anticipated."
Apple blamed a part of the weakness on China. Retail sales have been slowing there.
More recently, if you're wondering how sales are in China, just listen to the government scrambling to maintain demand. China's also warned their citizens that there's further risk of a slowdown.
China called out,
"There has been a more complex and severe environment facing our country's development this year... There are greater expected and unexpected risks and challenges, and we have to make full preparations for a hard struggle."
Putting it all together, China was a weak spot for Apple demand. Mobile makes up 40% of memory demand. While Micron is expecting a second half pick up, their largest end market is likely still going to slow. That can continue to put pressure on DRAM prices which weighs on company profits.
Inventory Build Up
How quickly can Micron cut capacity? They said they are cutting production capacity but they still have strong expectations for bit growth (their term for unit or volume growth).
For DRAM they expect 15% unit growth and for NAND they expect 35% unit growth.
Based on the environment those numbers sound pretty strong and I would guess there's downside risk to those numbers.
Also putting the price drops in perspective, the DRAM price drops likely mean a further lack of demand. Micron may need to further drop their bit growth assumptions to better align with demand.
In the meantime Micron appears to be letting their own inventories build up. That may show up in the next quarter's report.
Listen to what Micron said at a recent conference.
"I think, the good news is the cost structure of the product we are putting in the inventory is quite good. And so, I don't think we run into a situation where that cost is out of line with what we needed to be when we're ready to sell it. Also as you point out the obsolescence risk is very limited."
The way I read that is Micron's telling you they are producing more than demand. That's why they are "putting in inventory."
Their next point that they are careful that they don't see "cost out of line with (where they are going to) sell it" also carries risk.
Think about it. If DRAM prices are dropping 30%, the fastest in nearly a decade, putting production in inventory does carry risk. You may not have "obsolescence" risk because they can sell it, but at what price?
So this adds to risk for future margins. When comparing what they can produce it for vs. what they can sell it for in a buyers market.
So why not cut production more? Sounds like they either need a back half swing of demand or to cut production further.
It seems to me with Intel (NASDAQ:INTC), Nvidia (NASDAQ:NVDA) and Apple all recently lowering guidance, there's more risk than upside.
So, again, why not cut production? Because that hurts profits in the short term. Cutting production means you have to share fixed costs over fewer produced units which hurts your margins per unit. That's why they are producing and putting in inventory, as they said above. But that's a risky move. We pointed out Nvidia building inventories as risk call-out ahead of their recent guide down that hit the stock.
Some Lights Of Hope?
Nanya recently came out saying they expect DRAM price drops to ease in the second half. Initially that sounds like good news but I think it requires some more thinking.
We're not in the second half yet. We have another four months before we get there. Nanya may be responding to the current sharp drop in the first half. When factoring in more supply coming out of the market, they are assuming price drops should ease.
Elsewhere NAND prices were reported to start bottoming out and expected to move back up starting next quarter. That would be big news. Again, we're not there yet and DRAM is more important to Micron than NAND. But memory price trajectories can move in tandem and so it may be some light at the end of the tunnel.
In the meantime Micron's results about to be reported will include sharp drops in DRAM. Still the NAND prices solidifying could give Micron a datapoint to hold some confidence for the back half.
I think we're in a throes of a typical semi cycle. It may not be much to worry about longer term. The question is how long does it last?
This downcycle was most likely set into motion as the US and China duked it out in trade negotiations. That stalled companies from making big decisions and likely helped stall global economies.
The latest is President Trump realizes he needs a deal to help the stock market ahead of elections. I don't think a trade deal immediately snaps back demand but it's needed to stop the bleeding and shorten this semiconductor downcycle.
Micron reports later this month. DRAM prices are so key for Micron and affect their largest business. Price matters much more than units so dropping prices can hurt the income statement. That said NAND prices sound less weak.
Micron's back-half pickup expectations sound like they are walking a tightrope of hope in the face of major companies talking about a slowdown. It can happen but we need some things to fall into place.