RBC Capital is convinced that the market may not completely appreciate how Strategic Customer Agreements (SCAs) could impact Micron Technology, Inc. (NASDAQ:MU)’s earnings. On September 18, the brokerage maintained an Outperform rating along with a price target of $1,500 for the stock.
They suggest that the increasing demand from AI, combined with memory-heavy agentic AI workloads and limited supply, creates a positive scenario for Micron. Currently, at about 6.5 times forward earnings, Micron’s stock doesn’t seem to reflect the potential value from the company’s SCAs.
The rationale for investing in Micron has shifted; it’s not just about robust memory pricing anymore. Should these agreements provide a more reliable revenue stream, it may justify a higher valuation than what investors have typically reserved for companies in the cyclical memory sector.
Interestingly, Micron isn’t alone in reaping the benefits of the AI surge. There’s another memory-focused stock that has seen its value soar by over 650% this year, which is certainly catching the eye of investors.
Bull Case: SCAs Could Make Micron’s Earnings More Durable
Micron Technology, Inc. has inked 16 SCAs that encompass roughly 20% of its DRAM and one-third of its NAND volume across their contract durations. Typically, these agreements are set up as take-or-pay commitments.
Notably, the biggest contracts feature minimum and maximum price levels. Micron anticipates that the floor pricing on these deals will lead to better gross margins than what they’ve experienced in peak quarterly margins during past memory cycles.
The size of these contracts is quite impressive. According to Micron, 14 of the 16 SCAs are expected to generate approximately $100 billion in minimum-price revenue over their terms. Additionally, the company expects around $22 billion in customer deposits and related fiscal commitments from existing SCAs. Management indicated that once all planned agreements are finalized, at least half of Micron’s revenue could stem from SCAs.
The optimistic scenario hinges on Micron being able to leverage these SCAs to create a more sustainable cycle. If investors can be convinced that the company can sustain better margins moving forward, the current forward PE ratio might allow for upward adjustment.
Bear Case: The Memory Cycle Still Sets the Ceiling
However, memory prices might drop if the supply eventually meets the demand, and not every strategic agreement can completely mitigate that risk.
It’s worth noting that Micron has indicated that a subset of its SCAs do not include fixed pricing or price limits. Consequently, these contracts remain vulnerable to market fluctuations. The company has also pointed out that factors like customer demand, inventory tactics, and end-market conditions could change with time.
This perspective poses a challenge for investors, who may still see Micron’s earnings as typical of a cyclical memory stock even in light of the SCAs. The crux of RBC’s valuation argument is the durability of the current earnings landscape. A low forward P/E could be a signal for potential, but it might also be misleading if peak-cycle profits start to normalize.
Micron’s upcoming Q4 earnings report, expected on September 30, will be a crucial benchmark in assessing this outlook. Investors will be keen to see if pricing, margins, and the management’s forecasts align with the current favorable earnings environment.
Hedge Funds Moving in as Shorts Scale Back
According to Insider Monkey’s database, there’s a noticeable increase in elite investor interest in Micron Technology, Inc. A total of 184 funds were reported to hold Micron shares at the end of Q2, a rise from 154 in Q1 and 137 in Q4. While hedge funds are becoming more engaged, short sellers are scaling back their positions, with short interest now at 2.64% of the float, which is more than a 1% decline from previous levels.
The ongoing debate regarding Micron’s valuation essentially boils down to whether the SCAs can help the company prolong its exceptional earnings trajectory characteristic of the AI boom. RBC’s price target presumes that the market will eventually start valuing Micron based on its improved earnings predictability rather than on past memory cycles.
Though Micron does show promise as a potential investment, I think some other AI-related stocks may have greater upside and less risk. If one is looking for a significantly undervalued AI stock that could also benefit from onshoring trends and Trump-era tariffs, it may be worth checking out a free report on what could be the best short-term AI stock.
