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Micron Technology (MU) delivered strong revenue, cash flow, and business outlook in its Sept 25 report for the fiscal Q4 ending Aug. 29. This came from heavy AI-related spending by its clients. As a result, MU stock looks cheap here as its target price is now over 30% higher at $140 per share.
MU closed at $107.50 on Friday, Sept. 27, up from its recent low of $86.38 on Sept. 6. Analysts are reviewing the company's strong results and are raising their target prices.
I discussed Micron's return to positive free cash flow (FCF) last quarter in my June 30 Barchart article, “Micron Technology Stock Is Cheap Now With Its Return to Positive Free Cash Flow.” At the time I assessed its value at $162.44. My recent target price is slightly lower, given further guidance from management.
In any case, MU stock looks deeply undervalued here. I will discuss this below and a way to play this by shorting out-of-the-money (OTM) puts.
Strong Cash Results Despite Higher Capex
Micron reported 13.8% higher revenue at $7.75 billion in its fiscal Q4 from the prior quarter. Moreover, its quarterly operating cash flow of $3.41 billion was 37.5% higher on a Q/Q basis. Much of this came from strong AI-related demand in data center servers and associated DRAM memory chips from Micron Technology. As a result, the company said it now expects next year revenue will rise at least 15%.
Moreover, operating cash flow (OCF) grew from 36.4% of revenue to almost 44% (i.e., 43.9% of sales). However, this has also resulted in a huge increase in the company's capex spending. The table below shows that capex/sales ratios rose from just over 30% to over 40% of sales. That led to a slightly lower FCF number and a slightly lower FCF margin.
The CEO said in his prepared remarks that Micron will spend about 35% of sales next year on capex. We can use that guidance to estimate the company's free cash flow (FCF).
Estimating FCF Next Year
So, if Micron makes an average 44% OCF margin and spends 35% of sales on capex, its FCF margin should be about 9% of sales. That would be significantly higher than this past quarter and could lead to a much higher stock price.
For example, analysts now forecast $38.16 billion in revenue for the year ending Aug. 2025, up +52% over this past fiscal year's $25.11 billion. So, if the company generates 44% operating cash flow margins, its OCF could reach $16.79 billion (i.e., 0.44 x $38.16b). In addition, capex spending, at 35% of $38.16 billion in revenue would rise 67% from $8 billion last year to $13.36 billion if FY 2025.
As a result, FCF would rise to $3.43 billion (i.e., $16.79b OCF-$13.36b capex). That represents an 8.9% FCF margin on its projected sales of $38.16 billion next year. This $3.43 billion in FCF is over twice the run rate FCF for the past two quarters (e.g., $3.43b is 2.29x the run rate of $1.496 billion from the past two quarters - (i.e., $323m +$425m) x2 = $1.496b).
The bottom line is that given this guidance we can estimate a much higher target price for MU stock. Here's how.
Target Price for MU Stock
One way analysts use to value a company is its FCF yield (i.e., FCF/market cap). The metric assumes that 100% of FCF would be used to pay a dividend - so, what would the dividend yield be? Based on the stock's present dividend yield of 0.43% we can estimate that its FCF yield would be about 2.50%.
Here's why. Right now Micron spends $513 million on dividends (or 46 cents per share) annually, based on its recent annual cash flow statement. That is what produces the 0.43% yield (i.e., $0.46/$107.50, or 0.43%).
So, assuming (just theoretically) that 100% of next year's estimated FCF of $3.43 billion would be spent on dividends, the present dividend payment could rise by 5.9x (i.e., $3430 million/$513 million -1). In other words, the dividend yield would rise by 5.9x to 2.54% (i.e., 0.0043% x 5.9 = 2.537%).
As a result, if we dividend the $3.43b FCF estimate by 0.025, this results in an estimated market cap of $137.2 billion. That is 15.3% higher than today's $119 billion market cap. In other words, the stock price target is 15.3% higher at $124 per share (i.e., $107.50 x 1.153 = $123.95).
However, given the higher FCF margin and FCF number, the market could raise the valuation to a 2.0% FCF yield. That metric is the same as a 50x FCF multiple (i.e., 1/0.2 = 50x). So the market cap could easily rise to $171.50 billion (i.e., 50 x $3.43b est. FCF).
That market value is 44% higher than today's $119 billion market cap. In other words, MU stock's target price is $155 per share (i.e., $107.5 x 144 = $154.80). The average of both of these metrics ($124, with a 2.5% FCF yield, and $155, with a 2.0% FCF yield), is $140. This is still 30% higher than today's price.
Analysts Agree - Micron Stock is Undervalued
The average target price of 30 analysts surveyed by Yahoo! Finance is $155.91 and $148.30 with Barchart's survey.
Moreover, AnaChart, a new sell-side analyst tracking site, shows that their survey of 30 analysts is $133.40. That is still 25% higher than today's stock price of $107.50 and is close to my target price of $140, 30% higher.
Moreover, the table below from AnaChart shows that analysts have recently raised their price targets. Note that many of these sell-side analysts have very good track records.
For example, the circled analysts mostly have raised their price targets above today's price. Many of these analysts have met their price targets over 86% of the time. They also have high-performance scores as calculated by AnaChart over time.
One way to play this, in order to set an appropriate buy-in price, is to sell short out-of-the-money (OTM) puts in nearby expiry periods.
Shorting OTM Puts
For example, look at the Oct. 18 expiration period, three weeks away. It shows that the $100 strike price for puts, almost 7% below Friday's price of $107.50, trades for $1.49 on the bid side.
That represents an immediate 1.49% yield for the short seller of these put options (i.e., $1.49/$100.00). In other words, the short seller makes $149 for every contract he shorts after securing $10,000 in cash with their brokerage firm.
The worst that can happen is the investor could be forced to buy 100 shares at $100.00, i.e., $10,000 (if MU falls to $100 on or before Oct. 18). But having received $149 already, the investor's breakeven is $9,851, or $98.51 per share. So, the breakeven price for the short seller is 8.36% below Friday's close of $107.50.
Moreover, existing shareholders who own MU stock can benefit from any upside in MU stock based on its price targets described above. For example, let's they can repeat this trade every three weeks and make 1.49% each time. The expected return (ER) is almost 6.0% (i.e., $596 on the $10,000 invested 4 times).
This ER helps investors cover any unrealized loss in MU stock. It also provides an extra income source should MU stock stay flat over the next quarter. That is a slight advantage over short-put-only investors.
The bottom line is that this is one way to play MU stock which looks very undervalued at today' price.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
