Krause Fund Research Fall 2019 - Tippie.uiowa.edu

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Krause Fund Research Fall 2019November 15th, 2019Micron Technology, Inc. (NASDAQ: MU)Technology – SemiconductorsStock Rating:AnalystsTarget Price: 51- 54Ian Johnsonian-w-johnson@uiowa.eduAudrey Hefelaudrey-hefel@uiowa.eduDCF ModelDDM ModelRelative P/EInvestment ThesisMicron could improve their inventory levels sooner than webelieve. Supply has shown both DRAM and NAND memory chipsto be at high inventory levels. Micron has been working to reducetheir inventories with positive results occurring for the NANDmarket. The DRAM market could recover sooner than we expect ifdemand increases.Earnings EstimatesYearEPS2017 4.672018 12.272019 5.672020E 2.682021E 4.71 54 43 51Price DataCurrent Price52 Week High52 Week LowDrivers of Thesis: Micron trades at a discount to our target price range. Micron’sstock price as of November 15, 2019, is 47.71 while our targetprice range based upon our DCF Model and Relative P/E model ishigher at 51- 54. Additionally, throughout a difficult 2019 fiscalyear for the industry and Micron, the stock price ended higher thanat beFginning of the year. The semiconductor industry is bottoming and bound torecover. Since the end of Micron’s Q1 of 2019, demand levels havebeen low. Historically, down cycles do not last longer than a year,so we expect demand to recover. U.S. and China trade war will see progress over the next year.Given that a phase one trade deal will be official in the near future,the semiconductor industry will face less uncertainty.Risks of Thesis: HOLD2022E 5.882023E 6.692024E 7.20 47.71 51.39 28.39Key StatisticsMarket Cap (Millions) 52,662Shares Outstanding (Millions)1,114Beta1.71Dividend Yield0%P/E Ratio (TTM)8.50Profitability RatiosReturn on Assets5.88%Return on Equity7.88%Profit Margin13.50%Company DescriptionMicron Technology, Inc. (MU) manufactures anddistributes data memory and storage solutions. Itsells Dynamic Random Access Memory (DRAM)and NAND semiconductor chips. These chips aresilicon wafers that partially conduct electricity andare integrated into electronic devices. Micron’sfour main business segments are Compute andNetworking Business Unit (CNBU), MobileBusiness Unit (MBU), Storage Business Unit(SBU), and Embedded Business Unit (EBU).Micron was founded in 1978 in Boise, Idaho, andhas grown due to acquisitions and research anddevelopment.Relative Financial PerformanceStock Performance (Last 12 Months)Relative P/E12 Month Performance2020%1510%1050%0-10%MU-20%INTCP/E 2020MicronS&P 500TSMAVGOP/E 20211

Executive SummaryAs of November 15th, 2019, we recommend a HOLDrating for Micron Technology, Inc. (NASDAQ: MU) forthe University of Iowa Krause Fund Portfolio. Micron hasexperienced rapid growth in recent years and gainedmarket share in the DRAM and NAND memory chipmarkets. We believe their strong position and ability tonavigate this cyclical market makes them a soundcompetitor. However, the recent macroeconomic outlookpresents challenges for the company going forward. Withslowing GDP and on-going U.S. China trade war tension,the industry has experienced volatility and uncertainty.The company has also experienced supply issues andfaces the challenge of selling off inventory. Our forecastsincluded in the report along with the provided modelsupport our HOLD rating. We believe this rating isappropriate given their potential to perform better givenbetter economic circumstances. Our current price target is 51- 54.Economic OutlookRetrieved From: FREDWe reached an estimate of 1.7% by analyzing historicaldata from a similar capital markets context. Recently, theU.S. entered its longest bull market in history. The secondlongest bull market was from October 1990 to March2000.3 Historical data shows a trend of declining realGDP growth beginning at the end of the bull market inMarch 2000 until March 2003 when it bottomed at 1.7%.4Since we are in the longest bull market and anticipate itwill end before 2021, we believe 1.7% is an appropriateprediction when forecasting approximately three yearsinto the future.U.S. Real Gross Domestic Product (GDP)U.S. and China RelationsReal GDP is a key indicator of the overall health of theU.S. economy. It measures the value of all goods andservices produced in a given year. The four componentsof GDP are personal consumption, business investment,government spending, and net exports. Historically,personal consumption roughly accounts for 70% of realGDP1. Beginning in 2001, approximately 70% ofsemiconductor industry revenue has come from consumermarkets.1 With personal consumption as the largestcontributor to real GDP and industry revenue, acorrelation between real GDP and the semiconductorindustry cycle exists1. As a result, growth in real GDPsignals increased industrial output and related demand forsemiconductors. Meanwhile, stagnating or declining GDPgrowth signals less industrial output and demand forconsumer products. Real GDP as an indicator ofeconomic health and consumer spending activity makes itan important indicator for Micron.The U.S. and China have been in a trade war since 2017which has resulted in billions of dollars of tariffs imposedby both countries. Since the most recent trade talks onOctober 11, 2019, both countries have been working on aphase one trade deal that would enforce intellectualproperty rights, increase U.S. access to Chinese markets,and limit subsidies on China’s state-owned businesses.5The phase one deal could be official as soon as December2019.As seen in the graph above, in 2019, Q1 GDP growth was3.1%.2 In Q2, GDP growth was much lower at 2.0% andslightly lower at 1.9% in Q3.2 The decline in growthfrom Q1 to Q3 signals a slowdown in the U.S. economy.In alignment with the forecast of the St. Louis FederalReserve, we predict real GDP growth will be 1.95% in2020.2 We expect to see this decline in real GDPcontinue and reach 1.7% in 2023.Amid trade tensions, in May 2019 the U.S. placed HuaweiTechnologies Co., Ltd., a Chinese smartphone andnetwork supplier, on the Department of Commerce’sEntity List after identifying it as a national security risk.This prevented U.S. companies from supplying thecompany with technology from the U.S. The technologysupplied to Huawei is primarily in the form ofsemiconductor chips which are then used in theirsmartphones and network equipment. As a result of theban, U.S. companies like Micron could not sell theirproducts to Huawei.After receiving pushback from U.S. companies, the U.S.offered a temporary reprieve to allow them to work withHuawei until August 2019.6 That reprieve was extendedto November and is currently expected to receive a twoweek extension. According to the Trump administration,2

issues related to Huawei will face a separate negotiationprocess from the phase one deal and most likely bediscussed in the phase two deal.5U.S. and China trade relations are critical to thesemiconductor industry. Tariffs can result in moreexpensive goods due to artificially increased costs whichmay decrease consumer and business demand forelectronic devices that utilize semiconductors likecomputers, smartphones, and servers. Despite thereprieves and ongoing negotiations, the trade war hasnegatively affected companies in the industry by creatinguncertainty.If the trade war is not resolved, we predict these nationswill impose additional tariffs and trade bans oncompanies. It is possible that all Chinese imports into theU.S. could eventually have tariffs and China wouldrespond similarly. Trade bans on companies vital to eachcountry, such as Huawei in China, would most likelyresume in order to put pressure on each country to makea deal.However, if the U.S. and China reach an agreement,which we predict to occur by the end of 2020 due to aclose resolution on the phase one deal, the escalatingtariffs and trade bans would be removed. As a result, freetrade will resume, confidence in the economy will berestored, and U.S. companies like Micron will be morecompetitive in the global market.Consumer Confidence Index (CCI)The CCI is a measurement of how optimistic orpessimistic Americans are about current and futureeconomic conditions.7 This statistic is a leading indicatorof consumer spending. Because this indicator can predictconsumer spending, it is important in the semiconductorindustry and for companies like Micron. With a base of100 points, the CCI has fallen from July’s high level of135.8 to 125.9 in October.7 We believe this decline is dueto consumer uncertainty regarding the slowdown in GDPgrowth and unresolved trade war.While the CCI has declined, quarterly consumer spendinggrowth has decreased by 3% from Q2 2019 to Q3 2019.7We believe that the decrease in consumer confidence hasmaterialized through less consumer spending. Weanticipate the decline in real GDP growth and unresolvedtrade tensions to continue over the next year. With theseissues driving the decrease consumer confidence, weexpect consumer confidence to continue to decline andresult in less consumer spending. This will result indecreased demand for the industry’s end markets and hurtits profitability.InflationProducer Price Index (PPI)The PPI measures the average change over time in theselling prices received by domestic producers for theiroutput.7 The U.S. and China have placed retaliatory tariffson each nation’s goods. It is important to note if the tariffshave increased the price of goods because this may havean adverse effect on consumer spending that makes upmost of the semiconductor industry’s revenue.The graph below illustrates the monthly PPI levels for2017 to 2019.8 The blue line representing 2017 wasentirely lower than both 2018 and 2019 lines. This meansthat there was less change over time in the selling pricesreceived by producers. However, both 2018 and 2019lines are higher signaling higher selling prices received byproducers than in 2017. Since May 2019, the PPI has beenlower than 2018 levels which indicates a decrease in theaverage selling price to levels below this time in 2018.PPI 2017-2019205200195190185180CCI May 2019-October 2019175Points (Base 0125.9Data Retrieved From: Bureau of Labor 9Oct-19TimeData Retrieved From: The Confidence BoardThe recent downward trend in the PPI as of May 2019indicates that retaliatory tariffs are not materializing asincreases in the selling price received by producers. If thetariffs were creating artificially higher prices it wouldreflect in the PPI data. For the semiconductor industry,3

U.S. based manufacturers like Micron would find therecent PPI data important because it indicates tariffs havenot increased their selling prices to manufacturers ofelectronic devices which would then be passed along toconsumers.As a result, we believe the cost of tariffs have not beenpassed along to consumers because consumer spendinghas not fallen. It has remained around 3% growth levelsover the last three quarters.7 However, we believe that thetariffs can create uncertainty that may cause people to loseconfidence in the U.S. economy. This specific impact hasmaterialized in the CCI.Capital Markets OutlookThe U.S. economy recently experienced its longest bullmarket in history. However, indicators are signaling aslowdown in economic growth. The technology sectorand S&P 500 have a correlation of 0.94.10 A slowingeconomy would slow growth in the technology sector aswell as semiconductor industry Micron operates under.We do not anticipate positive market conditions for thetechnology sector and semiconductor industry based uponslowing real GDP growth, on-going trade waruncertainty, and declining consumer confidence.Industry AnalysisManufacturing & Trade Inventories & Sales (MTIS)The graph below shows the inventories to sales ratio forU.S. manufacturers from 2018 to 2019. This ratio showsthe relationship of the end-of-month values of inventoryto the monthly sales level. A high ratio meansmanufacturers have enough inventory to cover monthlysales. This indicator is important for semiconductorcompanies to look at because it signals demand formanufactured goods, most of which are electronicsrequiring semiconductor components. The ratio was 1.39for September and August 2019.9 However, in September2018 the ratio was 1.34.9 Over the past year, the ratio hasincreased which means manufacturers are increasinginventory or decreasing sales. A decrease in salescorresponds to the slowing GDP growth rate. We believethat the U.S. economy is showing signs of slowing downwhich a rising manufacturing inventories/sales ratiosupports.Inventories/Sales RatioManufacturing Inventories/Sales Ratio1.41.38Industry DescriptionThe semiconductor industry contains companies thatmanufacture semiconductor chips or semiconductorequipment. As shown in the graph below, global industryrevenues were relatively constant from 2012 to 2016.However, there was an approximately 78 billion increasefrom 2016 to 2017 and 52 billion increase from 2017 to2018.12 Revenue for 2019 is projected at 429.12 Webelieve this decline reflects the relationship betweenslowing real GDP growth and decreased demand forsemiconductors. For the first half of 2019, thesemiconductors sub-industry, in which Micron operates,represented more than 80% of industry revenues whilesemiconductor equipment companies contributed to 20%of revenues.13 Going forward, we anticipate thesemiconductor sub-industry to continue to dominate theindustry.Semiconductor Industry Revenue WorldwideRevenues (billions)The Manufacturing & Trade Inventories & Sales (MTIS)report measures product inventory values formanufacturers, retailers, and wholesalers as well as theinventories to sales ratio.9 This indicator is useful formanufacturers in the semiconductor industry becauseinventory and sales are critical to their ability to generateprofits. 500 450 400 350 475 422 300 315 429 340 335 344 300 250 200 1501.36 100 501.34 01.322012 2013 2014 2015 2016 2017 2018 20191.3YearData Retrieved From: StatistaTimeData Retrieved From: U.S. Census Bureau4

The four main categories of semiconductor chips basedon functionality are memory chips, microprocessors,standard chips, and complex systems-on-a-chip (SoC).15The two popular memory chips are Dynamic RandomAccess Memory (DRAM) and NAND Flash. DRAMsaves data when it has power, meanwhile NAND savesdata without power. Micron focuses on manufacturingboth chips.Manufacturers of semiconductor chips sell them tomanufacturers of electronic devices that eventually reachbusiness and consumer markets. The chart below breaksdown demand for semiconductors by end use. Themajority of demand comes from products ultimatelypurchased by consumers. As a result, the industry focuseson consumer driven economic indicators and revolves theindustry around consumer innovations. Micron focuseson consumer driven end markets by operating in thesefour business segments: compute and networking, mobile,storage, and embedded.2018 Total Global Semiconductor Market: 469 Billion(Percent of Semiconductor Demand, by End Use)1.0% merIndustrialComputerCommunicationsData Retrieved From: St. Louis Federal ReserveR&D ExpendituresThe idea of constant improvement in the industry isexpressed through Moore’s Law, the idea that the numberof transistors on a chip will double every year.15 This lawis the foundation of the industry’s competitiveenvironment and emphasis on research and development(R&D) to develop a competitive advantage.Out of all the U.S. industries, the semiconductor industrydevotes the second highest average percentage of sales toR&D.16 As seen below, over the past 20 years R&D as apercentage of sales has exceeded 10%. In 2018 alone, theindustry spent 17.4% of sales on R&D.16 R&D enablescompanies to innovate their products and expand into newmarkets by producing intellectual property. As a result,R&D leads to intellectual property that can serve as acompany’s competitive advantage.Data Retrieved From: Semiconductor Industry AssociationBusiness CycleSince 2001, approximately 70% of semiconductorindustry revenue has come from consumer markets.1Given personal consumption is the largest component ofreal GDP, there has been a historical relationship betweenthe industry and economic performance. The graph aboveshows the industry’s annual growth rate compared to theglobal GDP and U.S. GDP. This relationship wasespecially apparent during the economic downturnfollowing the tech bubble in 2000 and housing bubble in2007. As a result, the demand for semiconductors iscyclical. During periods of economic expansion, theindustry experiences high demand due to manufacturersproducing more electronic devices and consumerswanting to purchase them. To meet this demand, theindustry ramps up production and increases the supply.However, once the economy starts to slow down, thesemiconductor manufacturers race to sell off excessinventory so prices are not lowered due to marketoversaturation. In order for the industry to perform well,economic growth is essential.Data Retrieved From: Semiconductor Industry AssociationCapital ExpendituresThe semiconductor industry relies on capital expendituresto invest in property, plants, and equipment tomanufacture semiconductor chips. Since 2000, theindustry has made significant increases in capitalexpenditures as more goods contain chips and demandincreases. The past three years have seen the highestlevels of capital expenditures at 95.6 billion in 2017, 105.9 billion in 2018, and 97.8 billion in 2019.17

Companies must build their own fabrication facilities orrely on outsourcing to save money. According to Intel,building one modern fabrication facility can cost between 3 billion and 8 billion and this will only increase aschips continue to evolve.18 Consequently, a limitednumber of companies can afford to build and maintaintheir own facilities. This has led companies to outsourcetheir manufacturing to save money in an attempt to remaincompetitive in the industry.Recent Developments and Industry TrendsGrowth in M&ACompanies in the semiconductor industry operate in anextremely competitive environment. Semiconductorcompanies are turning to M&A to sustain profitability,seek new sources of revenue, and reduce revenuevolatility by diversifying their product portfolios.19 TheM&A value for the industry in 2014 was just 16.9 billionbut increased to 107.3 billion in 2015.20 It has sinceleveled off around 23 billion.20 Some companies thathave engaged in M&A deals include: Intel, Broadcom,and Micron.According to McKinsey, the most important contributorto growth for the semiconductor industry has beenventuring into the right new market.21 From 2005 to 2008,the new market a company chose to enter contributed togrowth, on average, 70% of the time.21 The second mostsuccessful growth method was M&A which contributedto growth, on average, 19% of the time.21 The increase inM&A value for the industry from 2014 to 2018 reflectsthe trend to rely on inorganic growth to spark the industryeven if it has not been the most successful method.Micron is positioning themselves to compete in newmarkets. In 2015, the company created a joint venturewith Intel called IM Flash to develop and manufacturenew 3D XPoint technology. This technology provides asolution to the gap in the memory market between DRAMand NAND. On October 31, 2019, Micron closed itsacquisition of Intel’s equity interest in the joint venturefor approximately 1.4 billion.22Also, on October 24, 2019, Micron announced it acquiredFWDNXT, a start-up affiliated with the University ofPurdue and developer of AI hardware and software.23 Byengaging in M&A activity, Micron is attempting tostrengthen its position in new 3D XPoint and artificialintelligence markets.Markets and CompetitionPorter’s Five ForcesThreat of New Entrants: LowFor the semiconductor industry, high start-up costs andcapital investments needed to create and develop thetechnology creates a major barrier to entry. The

audrey-hefel@uiowa.edu ian-w-johnson@uiowa.edu DCF Model 54 DDM Model 43 Investment Thesis Relative P/E 51 Price Data Drivers of Thesis: Micron trades at a discount to our target price range. Micron’s stock price as of November 15, 2019, is 47.71 while our target price range based upon our DCF Model and Relative P/E model is

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McKinsey approach in the Krause Fund program ever since launching the fund in 1998. The book was originally written as a consulting manual for training McKinsey associates on the value-based management philosophy used by the firm. The DCF and economic profit valuation approach taught in this text is widely used among investment professionals.

The fund's inception is 01/23/09. The fund invests in the following underlying funds: Russell 1000 Non-Lendable Fund E, Russell 2000 Non-Lendable Fund E, MSCI ACWI ex-U.S. IMI Non-Lendable F Fund (prior to 4/01/10, MSCI ACWI Ex-U.S. Non-Lendable F Fund), (prior to 3/01/09, EAFE Index Non-Lendable F Fund and Emerging Markets Non-Lendable F Fund), US