It's Time To Be Bearish on DRAM Manufacturers

Spot prices of DRAM modules have risen dramatically over the last year, mainly due to its limited supply. And a recent fire at one of the DRAM manufacturing facilities in Wuxi, owned by SK Hynix, further reduced the global DRAM manufacturing capacity by 13%.

This supply shortage pushed DRAM even higher, boosting the profit margins of Micron , SK Hynix, and Samsung . However, in light of some recent developments, there is reason to believe that this pricing advantage enjoyed by DRAM manufacturers could be short lived.


Rising Supplies
The fire-hit Wuxi plant, with a monthly production capacity of about 130,000 DRAM modules, had created a supply crunch of DRAM modules across the globe. But DRAMeXchange expects the plant to become fully operational during this January.

While the quick recovery is good for SK Hynix, it raises concerns regarding the global DRAM prices. In a research note, David Wong of Wells Fargo stated:

We think DRAM output from Hynix could rise substantially over the next few weeks while DRAM demand moves into the seasonally weak period of the year, potentially resulting in significant pressure on DRAM prices.

But, the DRAM output hike isn't attributable to just SK Hynix.

Shortly after the Wuxi plant caught fire, Samsung boosted its DRAM production by about 30,000 wafers per month to make up for the supply shortfall. This represents a 3% increase in the global DRAM production capacity. Now that the Wuxi plant is about to resume its full-fledged operations, Samsung hasn't yet announced any plans to roll back its production levels. In fact, heading into 2014, TrendForce estimates that Samsung will allocate about 25% of its manufacturing capacity for the production of DRAM modules - up from the current 20%.

These production hikes have led analysts at Wells Fargo and TrendForce to conclude that DRAM prices have peaked. And keeping these bearish estimates in mind, investors should tread carefully when considering Micron for investment purposes.

Impact on Micron
Micron is the third largest DRAM manufacturer, commanding an estimated market share of almost 27.4%. Its stock price has more than tripled over the last year, as its acquisition of Elpida Memory has strengthened its market position and expanded its manufacturing capacity. And the recent deal between Apple and China Mobile has made Micron an even more attractive investment option.

China Mobile is the world's largest wireless network company with about 760 million subscribers; starting this month, it will offer Apple iPhones on its fourth-generation network. Piper Jaffray analyst Gene Munster estimates that this Apple-China Mobile partnership will result in incremental annual sales of up to 17 million iPhones. Since Apple uses about 80% of Elpida's mobile DRAM manufacturing capacity, the incremental iPhone sales should fuel Micron's revenue growth.

However, investors shouldn't get too carried away with these bullish statements. Micron involves a great deal of risk as well.

Micron hasn't announced any plans to expand its production capacity yet. This can hamper its volumetric growth, and the memory module manufacturer might find it hard to grow its revenue if DRAM prices decline. Considering that Micron generates about 48% of its revenue from PC-DRAM sales, a slide in DRAM prices will have a direct impact on its profitability as well.

So, investors need to weigh the risks involved with investing in Micron. The Apple-China Mobile might boost Micron's volumetric growth, but the declining DRAM prices can offset those gains very quickly and result in dismal quarterly financials.

How to proceed
Reports by Wells Fargo and TrendForce suggest that DRAM prices could retract due to its rising supply, and RBC Capital doubts if Micron can retain its growth momentum. So, risk-averse investors might want to avoid investing in the memory-module manufacturer, due to its huge exposure to the DRAM industry.

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The article It's Time To Be Bearish on DRAM Manufacturers originally appeared on Fool.com.

Piyush Arora has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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