Micron Technology, Inc. (MU) Should Record Higher Margins, Profitability In 2014

Micron Technology, Inc.(NASDAQ:MU) should get increased returns in 2014 from its supplier deal with Inotera Memories, Inc., a leading Taiwanese DRAM memory maker. The deal should improve margins and profitability this year for Micron.

Based in Boise, Idaho, Micron Technology is one of the world's leading providers of advanced semiconductor solutions. Through its worldwide operations, Micron manufactures and markets a full range of DRAM, NAND and NOR flash memory.

Inotera contributes about 33 percent of Micron's DRAM, but starting 2014 100 percent of Inotera's output goes to Micron. For the December quarter, Inotera's gross margin were about 53 percent, but starting in the March quarter, its gross margin (GM) could step down about 500 basis points (bps) with increased GM contribution to Micron combined with the existing 35 percent of operating income contribution.

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Sterne Agee analyst Vijay Rakesh believes the increased GM and operating margin contribution could drive 5-10 percent EPS upside for Micron. Assuming flattish March quarter DRAM ASPs, Rakesh believe the increased 500bp GM contribution from Inotera should show up in the 33 percent DRAM revenues that Micron derives from Inotera.

Moreover, given the expanded Inotera DRAM revenues and profitability, the discount to the two-month average DRAM average selling price paid to Inotera will now expand significantly from the February quarter and through 2014 driving higher Inotera profit contribution.

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Micron gets 35.5 percent of Inotera's operating income categorized as "other operating income." Inotera's operating income in the December quarter about $357 million. Micron's share of this operating income comes at about $127 million or 11 cents a share.

As a result, Micron should report February quarter "other operating income" of about $127 million versus the market estimate of about $55 million, assuming no more debt restructuring charges.

Rakesh said Micron also has an increased profit-sharing agreement based on the current month's DRAM ASPs and the two most previous months (rolling three months schedule) and structured on ASPs and EBITDA performance and has a collar component in place, with profit contribution depending on quarterly performance.

Inotera noted that the primary focus of the large DRAM producers is producing sustained profits and that the structure of this contract will provide health to the entire ecosystem. In this scenario, the increased 500bp contribution to Micron should lower Micron's quarterly cost of goods sold by $21 million to $25 million driving improved gross margins.

In addition, the overall first half-January DRAM contract pricing reset more flattish and better than the DRAMExchange contract pricing coming down about 3 percent, even with Wuxi and weak PC builds. This makes sense as there are only three DRAM suppliers, with net DRAM capacity still coming down as Micron converts DRAM capacity at its Singapore fabs.

Micron should benefit from DRAM ASP trending up 10-15 percent. Also, December DRAM pricing trends continue to improve. The Yen/$ at 103 should be a modest tailwind versus about 100 Elpida base.

Rakesh noted Micron potentially providing clean non-GAAP earnings should allow investors to get a clean annualized EPS figure, which could show a $2.50-3.00+/year EPS run rate. Also, the RMBS settlement lowers litigation expenses and lowers risk of any potential, future litigation in DRAM.

There has been a lot of concern on DRAM pricing post Wuxi DRAM capacity coming back on line in January-March. A look at 2014 shows 2014 DRAM wafer capacity down 3 percent and similarly while there is a lot of concern on NAND, 2014 wafer capacity in NAND up up 10 percent - overall a positive and constructive memory capacity picture.

Revenue from sales of DRAM products were 69 percent higher in the first quarter of fiscal 2014 compared to the fourth quarter of fiscal 2013 due primarily to an increase in sales volume resulting from the acquisition of Elpida. Revenues from sales of NAND Flash products were up 8 percent sequentially, primarily due to an 11 percent increase in sales volume.

The company's consolidated gross margin improved to 32 percent in the first quarter of fiscal 2014 compared to 25 percent in the fourth quarter of fiscal 2013 primarily due to an increase in volume of products resulting from the acquisition of Elpida and to product mix.

Micron is also focusing on reducing operating costs (reportedly planning to cut jobs in Italy), which could be an added tailwind for the February quarter, combined with an increased profit sharing with Inotera.

For the first half 2014, MobileDRAM will be key with potentially higher density Galaxy S5, China and iPhone6 ramp. PC-OEMs are still focused on securing DRAM supply and less focused on DRAM pricing. That said, DRAM pricing could be stable in the first quarter 2014. A continued industry supply discipline in memory in 2014 will be a tailwind for Micron.