Say Goodbye to Micron’s Fat Profits

Soaring demand for PCs and other consumer gadgets during the pandemic created the ideal market conditions for memory chip manufacturer Micron (NASDAQ: MU). The average selling price for DRAM chips rose 8% in Micron’s fiscal 2021 as demand outpaced supply. Combined with higher bit volumes and the constant driving down of per-bit manufacturing costs, Micron’s profits went through the roof.

Micron churned out $5.86 billion of net income on $27.7 billion of revenue in fiscal 2021. For a producer of commodity products, sky-high margins are normal when the stars align. Strong demand pushes up prices, and that extra revenue flows right through to Micron’s bottom line.

But this situation was never going to last forever. Markets correct, and shortages give way to gluts. When demand starts to fall short of supply in a commodity market, prices can plunge rapidly. Combined with tumbling unit volumes, profits can very quickly dry up.

Oversupply has arrived

The first signs of trouble showed up in Micron’s fiscal third-quarter report in late June. Micron’s revenue and profits rose, but its guidance was a bit weak. The company pointed to softening demand for consumer electronics and high inventory levels at customers to explain the shortfall.

In just over a month since that report, the situation has become a whole lot worse. In early August, Micron disclosed that it now expects its fourth-quarter revenue to come in at or below the low-end of its guidance range. Inventory adjustments at customers have intensified, leading Micron to slash its expectations for industry bit demand. By the time the first quarter of fiscal 2023 rolls around, Micron expects its free cash flow to turn negative.

The company is cutting its capital spending plans in response. Micron now expects its total capex in fiscal 2023 to be well below fiscal 2022 levels. This is how cycles in the memory chip industry typically play out. Oversupply leads to tumbling prices and profits, prompting manufacturers to lower spending on capacity expansion. Demand eventually catches up and surpasses supply, leading to higher prices and profits. Everyone gets optimistic again and ramps up investments, which eventually leads to oversupply and another round of pain.

Each cycle is a little different. The pandemic created a historically lucrative environment for Micron, so my guess is the aftermath is going to be historically painful. Prices are dropping fast enough that you can expect Micron’s profits to contract quickly.

In early July, researchers at TrendForce revised down their outlook for DRAM pricing in the third calendar quarter. Previously, TrendForce was expecting a modest 3% to 8% drop in prices from the second quarter, with much of pain concentrated in PC and smartphone memory. TrendForce’s new outlook called for a 10% drop in prices overall, with an 8% to 13% drop for consumer DRAM chips.

A month later, TrendForce became far more pessimistic. They now see a 13% to 18% sequential decline in prices for consumer DRAM in the third quarter, and “the possibility of sustained decline cannot be ruled out.” Once one manufacturer starts slashing prices to move supply, other manufacturers have little choice but to follow suit.

No quick end in sight

This situation won’t end until customer inventory levels are brought back down. Given the state of the PC market, that may take a while. Gartner sees PC shipments dropping 9.5% this year , and desktop CPU shipments are at their lowest level in nearly 30 years as customers grapple with too much inventory. In other words, demand bouncing back isn’t going to save the memory chip industry. Instead, the painful process of bringing supply and demand back into balance will need to play out.

In cycles of the past, Micron would routinely post losses as the industry hit low points. That looks like a likely outcome this time around. Eventually, the oversupply in the industry will be whittled down and prices will stop declining so quickly. But until then, you can kiss Micron’s fat pandemic-era profits goodbye.

10 stocks we like better than Micron Technology
When our award-winning analyst team has a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now… and Micron Technology wasn’t one of them! That’s right — they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of August 11, 2022

Timothy Green has no position in any of the stocks mentioned. The Motley Fool recommends Gartner. The Motley Fool has a disclosure policy.

You May Also Like

About the Author: Over 50 Finance