DRAM & NAND: Betting On The Semiconductor Supercycle

“Digital technology, pervasively, is getting embedded in every place: every thing, every person, every walk of life is being fundamentally shaped by digital technology — it is happening in our homes, our work, our places of entertainment. It’s amazing to think of a world as a computer. I think that’s the right metaphor for us as we go forward.” - Satya Nadella, Microsoft CEO

If the world is a computer, storage and memory are the hydrogen and carbon molecules needed to sustain life. Because computers without memory are empty screens. Unable to perform the functions that give rise to technologies like AI and Deep Learning. Yet our world is moving closer and closer towards this computer-first reality. Smart home penetration is a perfect barometer. 48 million smart home devices entered new homes in 2019. This $27B market should grow near 21% CAGR for the next three-to-five years. And that’s just one example. As AI technology improves so does the number of potential applications. A few markets ripe for AI penetration include: 

• Automotive 
• Consumer Electronics
• IT & Telecommunication
• Medical 

But these markets won’t experience innovation without proper storage and memory technologies. Enter semiconductors. Last week we discussed why AI will turn semiconductors into a secular growth powerhouse. You can read that here. One major consequence of this new demand driver is the insatiable need for more data. McKinsey notes in their article, Artificial-intelligence hardware: New opportunities for semiconductor companies, the intensity of AI data storage needs (emphasis mine):

“AI applications generate vast volumes of data—about 80 exabytes per year, which is expected to increase to 845 exabytes by 2025. In addition, developers are now using more data in AI and DL training, which also increases storage requirements. These shifts could lead to annual growth of 25 to 30 percent from 2017 to 2025 for storage—the highest rate of all segments we examined.”

This week we’re focusing on public companies aimed at capturing this demand and turning it into record profits and margins. But before we dive into specific companies, let’s break down the differences between memory and storage. 

DRAM & NAND: Know The Difference

It’s helpful to think of memory and storage in two ways: 

1. DRAM is the memory used to store code for algorithms, processes, etc.
2. NAND is the memory used to store data for pictures, music, etc.

DRAM: Short-Term Memory

Memory uses DRAM (dynamic random access memory) to perform its functions. DRAM is a volatile memory, meaning it stores memory when a device is on. But when you power off, so strip the memory. When you think of DRAM, think of your main computer processor and graphics cards. DRAM is also used in portable gaming devices and video game consoles. There’s a few key advantages of using DRAM (via rfwireless-world.com): 

• Can be deleted and refreshed while running a program
• Smaller size
• Higher storage capacity 
• 100x faster than NAND

That said, there are drawbacks to DRAM memory, such as: 

• Data requires constant refreshing
• Complex manufacturing process
• Volatile memory

DRAM demand is here to stay thanks to autonomous driving, video game consoles and AI applications. Micron (MU) CEO Sanjay Mehrotra said (emphasis mine), “AI servers will require six times the amount of DRAM and twice the amount of SSDs compared with standard servers.”ATPInc wrote a great article on the massive AI-induced DRAM demand, saying (emphasis mine), “As AI workloads continue to grow, hyperscale data centers require more and more memory. In the first quarter of the year, DRAM supply remained tight mainly due to the massive construction projects of data centers, some of which are bigger than football fields.” Another ATPInc article highlighted the importance of DRAM in cloud computing technologies. The article reads (emphasis mine), “In recent years, the use of DRAM has been increasingly extending beyond the personal computer and consumer electronics sphere. Higher capacities and low latencies are among the driving factors why DRAM is figuring extensively in industrial applications such as smart factories, health care, military, automotive, networking systems and data centers.”Dram will also be critical to IoT bc of its low latency. For instance, According to Gartner, “driverless cars contain over 80 GB of DRAM versus 5.5 GB in PCs and 2.5 GB in handsets, exemplifying the sharp increase in the memory demands of these emerging technologies.”More companies will use AI and shift storage centers to the cloud. This will inevitably lead to increased DRAM demand and a sustained DRAM upcycle. But DRAM isn’t the only memory chip experiencing the AI demand bump. 

NAND: Memory At The Edge  

Storage is our long-term memory. It allows computers and applications to store large datasets, which it can then retrieve information when needed. There’s a few main differences between NAND and DRAM: 

• NAND doesn’t need power to keep data
• Ideal for portable devices
• Cost-effective per-byte with high storage capacity 
• Easily replaceable

NAND is the most exciting memory/storage component of the semiconductor technology stack. We’ll see more devices use AI-based technology at the edge. This will increase demand for NAND memory chips, which operate best at the edge due to their reduced energy requirements, portability and ability to store massive amounts of data. An IndustryResearch study reaffirms this belief in their report, GLOBAL 3D NAND FLASH MEMORY MARKET REPORT, saying (emphasis mine): 

“The global 3D NAND Flash Memory market size is projected to reach USD 47800 million by 2026, from USD 15540 million in 2020, at a CAGR of 20.6% during the forecast period.”

Why are they projected to grow at such a high clip? AI Adoption. Check out this statistic from Eetasia (emphasis mine): 

“AI technologies are now set to be rapidly adopted in embedded systems: analyst firm IDC expects the market for AI-optimized processors for edge computing systems to grow at a compound annual rate of 65% in the years to 2023. But this move to adopt AI raises questions about the sustainability of embedded developers’ current approach to the provision of memory for code storage.”

Flash-based (NAND) memory chips accounted for 17% of the global storage market in 2018. Toshiba estimates that by 2025, NAND memory will account for 40% of global chip storage. Again, the massive demand increase is driven by AI-enabled devices that need compute and storage power at the edge. ElectronicSpecifier reiterates the impotence of NAND memory devices for the future of AI-enabled technologies (emphasis mine): 

“Consumer products, such as smartphones, tablets and cameras, along with industrial equipment and sensors, automotive systems and medical devices, all rely upon flash memory, often integrated alongside their processors, that stores both data and the code they execute. However, data centres find attraction in flash memory due to its near real-time response to read/write requests, and high data transfer rate. As demand for massive data processing for artificial intelligence (AI) and machine learning applications grows, so interest in flash-based storage will evolve in tandem.”

Now we know DRAM, NAND and why we’ll see tremendous growth in both memory chips. Let’s review a few companies we can buy to express our bullish DRAM/NAND theory. 

Public Companies Dominating The Memory Market

The memory market is an oligopoly between five companies (market share in %): 

• Samsung (005930/SSNLF): 35% 
• Micron (MU): 16.5%
• Western Digital (WDC): 15%
• SK Hynix (000660): 9.5%
• Intel (INTC): 8.5%

An oligopoly in a commoditized market means one thing: lowest-cost competitor wins. In semiconductor language that means more storage space on less surface area. Yet the race towards smaller chips and lower prices resulted in a 46% price collapse in the NAND market in 2019. Thanks to the demand drivers, all these companies’ charts are setting up for very bullish moves. Let’s review our top three ideas in this space. I’ll provide a general description of the business, the bull case and what the charts are saying. Stick with us next week where we dive deep into an individual name that we love in this space.

Micron (MU): Our Favorite All-Around Memory Play

Business Description: Micron Technology, Inc. manufactures and sells memory and storage solutions worldwide. The company operates through four segments: Compute and Networking Business Unit, Mobile Business Unit, Storage Business Unit, and Embedded Business Unit. It offers memory and storage technologies, including DRAM, NAND, NOR Flash, and 3D XPoint memory under the Micron, Crucial, and Ballistix brands, as well as private labels. - TIKR.com

Bull Case: 

• MU is one of the cheapest NAND companies in public markets (2.3x EV/Sales & 5x EV/EBITDA)
• NAND memory accounts for 25-30% of total revenue
• 3rd largest DRAM manufacturer in the world
• 10%+ ROC over 30 years
• CEO an industry leader in non-volatile memory (NAND)
• Given memory chip price collapse, there’s fewer suppliers catering to more customers (demand/supply imbalance)
• Rise in demand should offset the natural decline in ASP (average sale price) of NAND chips
• Fewer players will result in focus on profit stabilization, not cost cutting and margin compression

Note: Alex sent out an in-depth MU write-up to Collective members this week. The full report is only available to Collective members. 

Valuation: 

• 5YR Average Growth Rate: 9.56%
• 5YR Average EBITDA Margin: 44%
• Capex as % of Revneue 5YR Average: 36%
• 2024 EV/EBITDA Multiple: 9x

The above assumptions get us ~$87/share by 2025. That’s 71% upside from the current stock price. 

Tape Reading: 

MU currently has a pattern within a pattern. Both bullish. The daily chart (shown below) reveals a bullish inverse H&S pattern: Now let’s zoom out further to the monthly time frame. The monthly time frame shows a coiling symmetrical triangle ready to propel higher: The stock is also above the 20MA pointing to further bullish sentiment. 

Samsung Electronics (005930/SSNLF): Our Favorite International Play

Business Description: Samsung Electronics Co., Ltd. engages in the consumer electronics, information technology and mobile communications, and device solutions businesses worldwide. It offers mobile phones, tablets, wearables, virtual reality, and audio products; TVs, and home theaters; OLED and LCD panels; laptops, computers, chrome books, HDM, memory and system LSI products, monitors, and printers; and home appliances, such as refrigerators, air conditioners, ovens, air purifiers, cooktops and hoods, microwaves, dishwashers, washers, dryers, vacuum cleaners, and heating products, as well as TV and home theater accessories. It also provides security and monitoring, trackers, Wi-Fi routers, hubs, sensors, outlets, and buttons. In addition, the company is involved in the technology and venture capital investment businesses; manufacture of semiconductor equipment and components; and provision of repair services for electronic devices. - TIKR.com 

Bull Case: 

• Samsung is the cheapest memory chip manufacturer in the world by quantitative metrics (1.23x EV/Sales & 4.67x EV/EBITDA)
• The company will invest a mind-numbing $115B into its semiconductor business over the next decade
• It commands top market share in NAND memory chip production
• The company’s stock rises and falls based off the results of two divisions: smartphones and semiconductors
• William Keating notes Samsung’s semiconductor prowess (emphasis mine): “Samsung is one of only two companies in the world to have demonstrated volume production on a 7nm process, with an impressive and credible roadmap all the way to 3nm. We believe that the true value of this capability will still take some years to be realised.”
• Samsung is one of the few companies with the supply capabilities to service the upcoming positive demand shock, as such, it will garner more of the operating profits
• The company might produce the world’s first 160-layer NAND memory chip
• Low expectations for revenue growth present low-risk upside optionality 

Valuation: 

• 5YR Average Growth Rate: 2%
• 5YR Average EBITDA Margin: 30%
• Capex as % of Revenue 5YR Average: 13%
• 2024 EV/EBITDA Multiple: 8x

The above assumptions lead to $66B in 2024 EBITDA. Applying our 8x multiple gets us $528B in Enterprise Value. Add back cash and subtract debt and you get $550B in shareholder value. That’s 56% upside versus today’s market cap of $325B. 

Tape Reading: 

Samsung’s tape looks very strong on the monthly time frame. The stock is breaking out of a three-year Cup & Handle pattern: A breakout above the neckline would also signal new all-time highs. 

Western Digital (WDC): Our Contrarian, Turnaround Play

Business Description: Western Digital Corporation develops, manufactures, and sells data storage devices and solutions. It offers client devices, including hard disk drives (HDDs) and solid state drives (SSDs) for computing devices, such as desktop and notebook personal computers (PCs), smart video systems, gaming consoles, and set top boxes; flash-based embedded storage products for mobile phones, tablets, notebook PCs, and other portable and wearable devices, as well as automotive, Internet of Things, industrial, and connected home applications; flash-based memory wafers; and embedded storage solutions and flash products. - TIKR.com 

Bull Case:

• Trades 1.18x EV/Sales and <6x EV/EBITDA
• Second largest manufacturer of SSD hard drives (behind Samsung)
• 1,400+ patents around NAND and SSD technologies
• Gross Margin will expand to 2016-2018 levels of ~33%
• Operating Margin will expand to 12-15% 
• Long-term support at current stock price
• Company repays debt, buys back stock and pays a dividend (5%)
• Company will deleverage as it moves through the more bullish part of the cycle

Valuation: 

• 5YR Average Growth Rate: 4% (GDP-type growth)
• 5YR Average EBITDA Margin: 15% (vs. historical 13-21% estimate)
• Capex as % of Revenue 5YR Average: 4.2% 
• 2024 EV/EBITDA Multiple: 8x

The above assumptions lead to $20B in 2024 revenue and $3.55B in EBITDA. Applying our 8x multiple gets us $28.4B in Enterprise Value. Subtract $7B in net debt and you’re left with $21.4B in shareholder value, or $70/share. That’s an 84% upside from current prices. 

Tape Reading: 

WDC’s a picture-perfect bottom-picker’s stock. Price is currently anchored to a long-term support level of $38/share. You can clearly see the support when viewing a monthly chart (see below): The current price offers a great reward/risk trade set-up. Investors can buy at the close of this month’s candle with a stop below support (around $33/share). 

Risks To Companies' Bull Thesis

There’s a two main risks we’re worried about with our bullish NAND thesis: 

• Competition from Chinese chip manufacturers

China’s investing $100B to bring chip development to the mainland. China chip success would mean less revenue from companies like MU, which generate roughly 50% of their revenues from China. New Chinese entrants would also likely result in price wars and lower margins. Currently, the oligopoly is best served to stabilize prices and enjoy generally high profit margins for everyone. 

• Global Macro Slowdown

As the general economy goes, so do semiconductor companies. A global slowdown would reduce semiconductor orders and R&D.