How Low Can Micron Go? Quite A Bit, If You Believe These Metrics

In a report published Wednesday, Morgan Stanley analyst Joseph Moore discussed why he believes shares of Micron Technology, Inc. (NASDAQ: MU) can continue trading lower.

According to Moore, weakness in DRAM pricing is expected to continue in the near-term, undergo a "brief improvement" during the seasonally high fourth quarter, only to enter 2016 with "substantial uncertainty."

Meanwhile, DRAMexchange reported prices for July (down 15 percent for PC DRAM) were worse than what the analyst had expected. At the same time, various media reports suggested that Samsung intends to cut production of its PC DRAM, and reallocate to server and mobile – a move which is "not particularly good" as there is already oversupply in server and mobile as well.

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"Bulls that we talk to raise the question: if things keep getting worse, are we close to downside protection for Micron stock?" Moore wrote. "The short answer is that we don't think there is strong valuation support near term, and see the stock going lower."

A 'Difficult Exercise'

Moore continued that valuing Micron's stock is a "difficult exercise" given "minimal" historic earnings power through cycles. Even though there have been "clear structural" improvements in Micron's earnings power, that still leaves the question of what long-term earnings power actually looks like as last year's earnings per share of $3.24 "is not the norm."

Moore further noted that evaluating the stock through traditional metrics (P/B &EV/Sales) results in a tangible book value of $10.28. However, this valuation is too low and understates the Elpida assets that were acquired at a substantial discount to their book value. As such, a more appropriate book value for the stock would be around $12.77 - not far off from an EV to sales multiple which leads to a $13 valuation.

On The Other Hand...

Valuing manufacturing assets at replacement cost places Micron's stock at $25 per share. The analyst did note there "is room for debate" given a lack of concrete data on wafer supply by process code. Nevertheless, looking at replacement cost valuation "does signal value" to industry participants as it is "particularly relevant in a strategic context."

Bottom line, a replacement value assumes a potential M&A outcome, a scenario which Moore characterized as a "potential factor but probably not an imminent one." As such, under a "bear case scenario" the stock could see downside to $13 while the replacement cost of $25 signifies near-term upside from a potential buyer.

"In an environment where stocks tend to overshoot to the downside in the short term, these valuation metrics demonstrate the wide range of price outcomes if we choose to take a step back from traditional next fiscal year earnings multiples," Moore concluded.

Shares remain Equal-weight rated with an unchanged $19 price target.