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This report was included in The Value Line Options Survey on November 7, 2014, and the closing price for MU was $33.01.

This is the twelfth of a series of articles relating to enhancing investment income through the sale of options. Our thesis is that the most favorable opportunities in this regard are based on the sale of “out-of-the-money” covered call and/or cash covered puts on stocks with a market capitalization of above $10 billion, good near-term share-earnings growth prospects, and relatively attractive valuations. Our current selection, Micron Technology (MU), is a leading producer of computer memory, which has been in very strong demand lately. Fortuitous acquisitions in 2013 and increasing technology contributions from a joint venture with Intel (INTC - Free Intel Stock Report) have been other catalysts behind the company’s impressive top-and bottom-line momentum in fiscal 2013 and 2014 (ended August 28th).

Company Background

Micron was founded in Boise, Idaho in 1978 as a semiconductor design consulting company. It started producing dynamic random access memory (DRAM), the main working memory for computers, and NAND flash, used for data storage, in 1981 and 1984, respectively. Micron’s joint venture with Intel has considerably expanded its DRAM and NAND flash memory capabilities in recent years. The company also began a partnership with Photronics (PLAB) to supply high-density low power chips, and another with IBM (IBM - Free IBM Stock Report) that entails that company’s 3D chip making process. It also made several acquisitions that greatly expand its chip production capacity. The latest occurred in 2013, when it purchased Japan-based Elbita Memory and Taiwan-based Rexchip Electronics. At present, it owns seven wafer fabrication plants located in the United States and Asia. These facilities, along with those operated by two joint ventures, provide almost all of the company’s chip requirements.

At present, Micron has an estimated 25% to 30% share of the DRAM market, tied for second place with Korea- based SK Hydrix and behind leader Samsung Electronics. In the past, Micron produced less sophisticated chips, with a focus on profits. But now, thanks in part to its joint venture with Intel and contributions from Elbita, Micron is one of the cutting edge players in this expanding industry. Indeed, in fiscal 2014, its sales and net profit jumped 80% and 156%, respectively, to $16.4 billion and $3.0 billion.

Backed by R&D expenditures of at least $1.5 billion and a capital budget of around $3.8 billion, Micron’s focus for fiscal 2015, beyond ongoing advanced component and technology development, is on expanding capabilities, optimizing manufacturing capacity, and, in particular, enhancing its value-added portfolio.  Along with good prospects for the data memory and storage markets, these planned measures augur well for solid sales and operating margin increases in the current fiscal year.

Favorable Industry Dynamics

Computer memory is in strong demand and DRAM chip prices are holding at relatively high levels. Demand is being fueled largely by the growing computational needs of smart phones and of sizable enterprises for data analytics. Also, personal computers still account for 30% of DRAM memory demand, and with Microsoft (MSFT - Free Microsoft Stock Report) discontinuing support for its Windows XP operating system earlier this year, this equipment has been replaced at an elevated pace in recent quarters.  And flash memory should continue to gradually replace mechanical hard drives, due to its faster access speeds and lower power consumption. Too, ample opportunities in automotive and industrial end markets augur well for broad-based top- and bottom-line advances in the coming years.

Meanwhile, the traditional price decline for memory chips following periods of profit spikes is being held in abeyance. The number of key DRAM players has dropped from more than 20 in the 1990s to three at present, which has created more discipline on supply. Moreover, the rapidly increasing complexity and cost of adding memory density to chips appears to be moderating the rate of supply expansion.

Investment Attractions

Following Micron’s August-period financial report, the consensus earnings estimate for fiscal 2015 increased modestly, to about $3.70 a share. Based on that target, the P/E ratio is only 9.0. This valuation seems to reflect the company’s historical earnings pattern, rather than accounting for the numerous positive developments that we have mentioned.

Other favorable considerations are the $2.2 billion of free cash flow generated in fiscal 2014, despite a $1.7 billion jump in capital expenditures, the 28.3% return on shareholders’ equity, and a solid balance sheet.

Option Strategy

Micron Technology stock has traded between $26.32 and $34.85 during the past three months, and has been in a strong rebound since mid-October. There appears to be good support in the $30-$32 range. In light of the foregoing factors, the potential annualized yield from the sale of either a  covered call with a strike price of $35 or a cash-covered $31 put, both expiring on December 20th, appear to be quite attractive. Indeed, based on the respective bids of $0.95 and $0.84 ($95 and $84 per option) at press time, the yields are about 23% and 22%.  Note, too, that the December 20th expiration date is prior to the next scheduled earnings release, which is a positive consideration for the prospective sale of these options. 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.