Micron: Mohnish Pabrai’s Favorite American Semiconductor Stock

Global semiconductor revenue in 2022 is forecast to grow 11% and reach a record-high of $680.6 billion, and this is after revenue soared 25% in 2021 according to IC Insights. The world’s thirst for semiconductors is driven by the abundance of cell phones, portable technology, 5G and even the budding market for IoT (Internet of things) devices.

Value investor

Mohnish Pabrai (Trades, Portfolio)’s top U.S. holding as per his latest 13F report is Micron Technology Inc. (MU, Financial), which is poised to benefit from these trends as the fourth-largest semiconductor company in the world. The firm is one of only a handful of semiconductor manufacturers with the capability to produce Dynamic Random Access Memory (DRAM) chips; you may have seen their brands Micron and Crucial if you’ve ever upgraded your laptop’s RAM (Random Access Memory).

Business model

Micron makes 71% of its revenue from DRAM and 26% from NAND, which is used in solid state hard drives (SSDs). These have many applications, including computers, mobile, automotive and even Cloud.

The market for 5G cell phones is an especially interesting tailwind for the company, as 5G-enabled phones have 50% higher DRAM and double the NAND content versus 4G phones. Revenue from 5G smartphones is expected to reach $337 billion for the industry by 2025, up from $108 billion in 2021, according to Juniper Research.

Micron has 13 Manufacturing sites, 14 customer labs and 40,000 team members. They have multiple sites internationally in the U.S., Europe, India, Malaysia, Taiwan, Singapore, Japan and China.

As a technology company, Micron must continually innovate to stay ahead. Thus, they are investing heavily into R&D, dedicating 10% of revenues, or approximately $2 billion per year. According to their investor relations presentation, the company’s strategy going forward includes reducing manufacturing costs and increasing density per wafer.

Mohnish Pabrai (Trades, Portfolio) has been buying

Pabrai has been investing in Micron Technology for a very long time. Most recently, he added 15% to his position in the fourth quarter of 2021, during which shares traded for an average price of $78.57. Pabrai has often stated that he is not afraid to make focused bets and would be happy to hold a single stock if he knew it had the best return potential.

We can’t get a full picture of Pabrai’s investments, since most of them are not listed on U.S. exchanges. Pabrai has long since moved the majority of his investment funds to the Asia region as per his own admission, and the SEC only requires holdings to be reported on the 13F form if they are listed in the U.S., whether it’s a common stock or an American depository receipt.

However, from Pabrai’s latest 13F report, we can see that Micron stock now makes up 78% of his U.S.-listed equity holdings, even though it’s likely a much smaller percentage of his assets under management.

Gurus such as

Paul Tudor Jones (Trades, Portfolio) and
Ray Dalio (Trades, Portfolio) were also buying shares of Micron in the 2021 fourth quarter.

Competitive advantages

As a true value investor who follows

Warren Buffett (Trades, Portfolio)’s style, I would expect
Mohnish Pabrai (Trades, Portfolio) to invest into a firm with a moat or competitive advantage, and Micron does not disappoint. They have over 44,000 patents and advanced manufacturing technology, which is vital for semiconductor manufacturers.

Micron produced strong earnings results in 2021, with revenue jumping 29% to $27 billion. Gross margins also increased to 37% of the revenue, while net income increased by an amazing 118% to $5.9 billion. The firm’s cash position also increased to $8.6 billion. In addition, Micron’s investments are paying off well as the firm’s return on capital is 14.6%.

Is the stock undervalued?

I have plugged the latest financials into my valuation model, which uses the DCF method for valuation. I have estimated that the firm will grow revenues 25% next year, which I believe is conservative (they grew revenues 29% in the year prior). Afterwards, I have predicted revenues to grow at 15% for the next two to five years (most analysts on Wall Street predict around 23%). I have estimated margins to remain stable at 24%.

Given these assumptions, I get a fair value estimate of $111 per share. The stock is currently trading at $73 per share and thus is 35% undervalued. According to the GF Value line, the stock is fairly valued.

The firm is also trading at some of the lowest price-earnings ratios and enterprise-value-to-Ebitda ratios that it has seen over the past year. The price-earnings ratio of 6.5 is much lower than the U.S. semiconductor industry average of 15.

Risks

There are a variety of risks for the firm, the first is what I call “the Intel (

INTC, Financial) problem.” If there is a production issue and Micron falls behind in terms of product development, then they may lose business. This would be comparable to what happened to Intel when they fell behind with their 7nm chip.

Losing access to the Chinese market is also a risk for Micron. Goverments have become more focused on structural independence since the supply chain issues from the pandemic began, and China is no exception. According to Micron’s Investor presentation:

“The Chinese Government may restrict us from participating in the Chinese Market and may prevent us from effectively competing with Chinese Companies.”

Conclusion

Micron is a fantastic company and a true leader in the semiconductor industry. The firm is ahead of its competitors in many technological areas and continues to innovate. They are growing fast and increasing margins.

The semiconductor industry is tremendously fast-paced, volatile and cyclical. Thus, I would expect lots of this moving forward. The valuation is looking attractive after the company had a bad quarter, and

Mohnish Pabrai (Trades, Portfolio) likes the stock, so I believe it could be a value opportunity for the long-term investor.