The New Portfolio and First Position.... (Patreon)

The new portfolio is up and running. I decided to go with TD Ameritrade. 

I was really tempted to use Robinhood for the memes, but figured using a big boy brokerage is probably a good idea. They have a good trading platform (thinkorswim), and I was able to get access to level 3 options trading (why yes of course I'm a college student with 25+ years of options trading experience).

I also funded the account with some money to get us started. Patreon unfortunately doesn't payout until the beginning of next month, so you'll have to wait to see your hard earned dollars get donated. However don't worry, I promise they will get donated to Wall Street. 

The First Position: Micron Technologies ($MU) 

Micron Technologies is a company that manufactures semiconductor components. Most of you probably know about the semiconductor shortage, or at least know enough to know that it's why PS5s are being resold for $1000.

In short, the culmination of a few different global events/macroeconomic trends drastically increased demand for different semiconductor components vastly outweighing supply. 

There are a lot of external variables affecting the semiconductor market. Being that semiconductor components have become largely technologically homogenous over the last few years, it makes the most sense to look at them as a commodity. Individual manufacturers with no real "edge" scrambling for market share. 

Think about it this way,

There are a bunch of different manufacturers that use semiconductor components (for example, DRAM, which makes up 67% of MU revenue). These components are rapidly becoming more common in different industries as computing is introduced into those industries. Wherever you can find computers, you can find semiconductor components like the DRAM Micron sells. 

The problem is that a company like Micron doesn't actually influence semiconductor demand. Demand for different consumer electronics, cars, and computers, increases demand for semiconductors downstream. As it turns out, economists are absolutely terrible at forecasting how consumer demand will change into the future. What does this lead to? Plenty of disequilibrium between supply and demand in the semiconductor market.

Right now, we're living through a big semiconductor shortage. This basically means that companies like Micron are able to charge more for their products. However the big question is whether or not this pricing power has been fully priced by the markets. In Micron's case, I'd say it hasn't. 

These improving market conditions, combined with our significantly stronger competitive position, set us up to generate stellar financial results in the second half of the fiscal and calendar year.

-Dave Zinsner, CFO of Micron

"I'm jacked to the tits in calls" 

-Random guy on Wallstreetbets

 The main Micron investment thesis is simple:

Around 67% of Micron's revenue comes from DRAM. They sell other components, but being that the largest consolidated portion of their revenue comes from DRAM, that's what I'm going to focus on from a risk perspective. 

DRAM is undersupplied, which is a huge industry tailwind that supports Micron's pricing power in the short-medium term. Despite DRAM making up a massive portion of their revenue, its uses are diverse; it's not vulnerable to demand shifting from individual market sectors. 

There are only a few companies making the world's semiconductors. Despite semiconductor technology being widely accessible, building the infrastructure required to manufacture semiconductors is incredibly capital intensive and time consuming: a moat. 

There are a few other factors that go into this, but when simplifying the Micron thesis, these are the most important ideas.  

Optimistic forecasts predict the shortage is most likely to last 2-3 more quarters. Intel's CEO predicts we'll remain in "severe shortage" territory for a few quarters, then move into a moderate shortage for the next few years. While we can't predict what will happen more than a few quarters out, we can say a few things with some degree of certainty-

The present conditions are creating an optimal environment that supports Micron's top line revenue growth and margin expansion. Micron has guided for $7.1b in revenue for the next quarter and will likely update us on how the crisis is affecting DRAM pricing on the next earnings call. For FQ3’21, Micron already expects massive Q/Q growth in its gross margin to above 40%. 

Management has a history of beating earnings estimates, with a history of 8 beats in the past 2 years. This doesn't really mean anything, but it does serve as good confirmation bias for the position. 

Valuation

Overall, we're banking on the cyclical change of MU's revenue and margins. As of right now, the company trades at a 5x EV/EBITDA multiple. Based on the 8x TTM (trailing twelve month) EBITDA multiple we've seen, if we're projecting 20 billion in EBITDA based on forward guidance for 2022 (MU's fiscal year actually ends in August), we can anticipate an enterprise value of around 160 billion. Being that MU's EV is 86 billion today, we're looking at around 86% on the upside. 

Of course... It's not that simple. MU's historic average EBITDA multiple has been closer to 4x, and with fears of DRAM over saturation, I'm hesitant to say we'll see that 8x EBIDTA multiple in the next few quarters. That's the goldilocks outcome, but I'm not sure of a catalyst that would make investors price the stock with such positive expectations of the future. From what I've read, most people see the cyclical nature of the semiconductor market and are trying to get in at the beginning of a big upswing. Just looking at MU's history we can see these manic cycles play out. 

If history repeats itself, I think we'll sit in line with an inflated, but more realistic 6x EBITDA multiple while MU's pricing power still exists. This would bring MU's EV to 120 billion and give us 39% on the upside. Does history repeat itself? Not when I'm holding a position. 

Looking at management's track record, their forward guidance, as well as the favorable economic tailwinds, $110/share is a conservative and fair price. Most analysts see it right around the $110-120 region. That being said, seeing all the bullish sentiment is scary. Whenever I see that I think "ok there's no way we're all gonna make money right?" 

Catalysts 

Q2 Earnings on June 30 - GUH  

How to take advantage of this 

What, in my opinion, is the best way to capitalize on this opportunity?  A combination of long stock and call debit spreads. Being that I'm planning to average into this position over a matter of time, I'm starting with a 50:50 ratio between the two; however, that may change. 

Being that I think this play will take multiple quarters to become fully priced, a narrow spread between long and short options makes the most sense. This limits our short term upside potential, but hedges against the stock moving sideways. I chose the following strikes/expirations

Something interesting you might notice is that we hit our max profit if the underlying trades completely sideways. This is because the theta of our short leg is higher than the theta of our long leg. However, unlike a naked call, in most scenarios we have to wait for the extrinsic value of our short option to decay if we want to hit max profit. Short term, bigger upward moves in the underlying don't affect the value of our spread as much as a naked call would. That being said, I'd rather allow the adjacent greeks of the long/short calls to cancel out making the position short theta. That probably makes absolutely no sense. 

Call we sold = time decay very GOOD

Call we bought = time decay somewhat BAD 

Add the two together = time decay (net) GOOD 

The extrinsic value of our short option decays faster, which means we're net short theta. That's good for a position that might take multiple earnings cycles to payout. Also, because $MU (and the entire market) is at a relative low IV, I'd rather be a net buyer of options than a net seller. IV is considered "mean reverting" so in general you want to buy options when a stock is below its 50% percentile rank. MU is currently at 38%

One other consideration with debit spreads is liquidity. Multi-legged option strategies are much more difficult to close out early. This is especially true as they get deeper ITM. That being said, this is in a best case scenario where our spread is already deep ITM. I'll be monitoring the position and if liquidity becomes a concern, I can always reopen another more liquid spread closer to ATM. 

Anyway, that's just all the complicated technical option stuff that doesn't really make a difference if you don't know how to predict the future. You can have a perfect strategy buying low IV options that are incredibly liquid with the right spread width, but if you don't predict whether stonk goes up correctly, none of it matters. 

That'll most likely be the case with this position. 

What's the Exit Strategy? 

If we're to assume that MU at $110/share is fully priced, that seems like a decent exit point. That being said, we'll have to reevaluate in the future based on the duration of the semiconductor shortage. As long as Micron's pricing power is reflected in revenue/margin expansion, I'm holding this shit. 

What If I'm Wrong

Correction: when I'm wrong, how will I react? How far would $MU have to drop for me to be convinced I'm wrong? If we see a quarter of margin and revenue contraction, the premise of the entire thesis is wrong. I'm 99% certain this is what will happen.   

Let me know where I'm wrong, and what company you want to see analyzed next!

*This is not financial advice. Inverse everything I do and say if you want to make money*