Morgan Stanley continues to see a positive trade in MU, as the above cycle earnings in memory look likely to continue. Morgan Stanley has projected that capital spending will continue higher, and nothing from the Hynix quarter changed Morgan Stanley view as Hynix supply is basically in line.
Micron sold off 5.6% on Tuesday post the Hynix quarter, on concerns over supply and sustainability. Specifically, Hynix cited that they would increase DRAM wafer starts 3-5% this year and hinted that capital spending would go higher. Morgan Stanley expects capital spending to go higher, because of the elevated level of EBITDA across the memory sector and think that eventually spending will overshoot and cause oversupply, which describes every memory cycle in history.
But the details and the timing, is important and we would note that the Hynix view of 2017 supply is basically unchanged despite the slight increase in wafers. Morgan Stanley continues to see Micron climbing a wall of cynicism and worry as memory is likely to remain robust near term and some of the 2h17 increase in capital spending is aimed at NAND-to-DRAM conversion - which could actually help the market short term as 10%+ of global NAND supply comes offline during the transition.
Morgan Stanley price target is the midpoint between the base case and the bull case. Morgan Stanley base case of $27 assumes 12x through cycle earnings of $2.25, reflecting roughly the intrinsic earnings power of the company through cycles. Morgan Stanley would concede that this is a difficult number to triangulate as earnings oscillate from $0.06 in FY16 to a $7+ run rate now, but the average earnings power of the company in the last few years has averaged roughly at about this level. $2.25 is the average level of annualized EPS over the last 16 quarters, which Morgan Stanley thinks fairly reflects the economics of the current DRAM environment. Morgan Stanley would put a low multiple on that equal to where the stock has traded historically given both the historic volatility and unpredictability of earnings and the large differential between depreciation (currently 19% of revenues) and capex (which the company has indicated will average about 30% of revenues over the longer haul).