[Citi, Bear Stearns, and Goldman Sachs post-earnings excerpts below]
Somewhat as expected SanDisk blew away earnings, the market shrugged and then went looking for things not to like. Add in a big drop in the Nasdaq coupled with some folks with deep pockets betting on the downside and voilà, a 15%+ drop to $42 and change.
When SanDisk is described as volatile & high risk, it’s because of days like these. It comes with the territory. Rather ironically, all this in the face of great earnings and great long term prospects. Go figure.
To each their own. I trade around a core long-term position. Personally have done the best with both FLSH and SNDK, buying when the crowds were running for the exits.
Usually at times like these, analysts are on the other side. Curiously this time around, for the most part, this isn’t the case. Most seemed to hear the same positive call I did.
Personally picked up a few more shares on Friday. If we get another leg down, will pick up some more.
Whether this will work out is anyone’s guess, but (general market willing), suspect I will be able to sell these in the $60s/ $70s+ within the next 9 months when the sexy SSD story starts getting play. If I need to wait a bit longer, that’s OK too.
In general, my take is that SanDisk needs to string a few strong quarters together to be taken seriously by the Street. Fundamentals seem intact. Now SanDisk has to execute.
Also it probably wouldn’t hurt if one of these days the naysayers were to be burned big time. Teach them a lesson and they might back off, and look for easier pickings.
In any case, Q4 looks like its in the bag. Some analysts expect to be disappointed, but I don’t. Consensus for Q4 is something like $1.27B and $0.62. Hitting/exceeding these numbers shouldn’t be a problem, given Q3’s across the board product momentum, strength in license/royalties and SanDisk’s surprisingly strong Q4 product GM guidance.
Q1 looks to be shaping up as the “show me” quarter. The bears seem to be expecting a repeat of Q107 where excess NAND MLC coupled with soft seasonal demand in retail triggered sharply lower NAND pricing, which in turn destroyed GMs.
There are reasons to think that Q108 will be much better than Q1 2007. Both Samsung and Hynix face significant 200mm fab de-commissions in 2008. Dumping NAND would seem counter-productive, when they’ve got looming capex issues.
According to Credit Suisse SanDisk/Toshiba is “about half a year ahead of the Koreans” in NAND technologies. If the Koreans want to play hardball on price, SanDisk is better positioned now than in Q1 2007. This should act as a deterrent.
Then there is the supply demand balance. Personally, think the mobile monster is under-appreciated. In Q1 2008, mobile is going to soak up a lot more NAND than it did in Q1 2007.
Today SanDisk is selling more than 1M cards/day. About half of these are for the mobile market. More mobile cards were sold in Q3 than in all of 2006. In Q3, SanDisk’s mobile unit sales accelerated to 41M units, a 36% Q/Q increase. While there is seasonality to the phone business, this explosive ramp of mobile flash storage shows no signs of taking a break in Q1 2008.
Another potential catalyst for SanDisk’s Q1 2008, is SNDK’s rapidly increasing international strength. In Q3, SanDisk’s international sales grew nicely reaching 67% of total product sales. SanDisk is only now beginning to have a presence in many international markets. Upside is wide open. In Q1 2007, SanDisk wasn’t positioned to take advantage of these international opportunities.
Time will tell the Q1 story, but personally am cautiously optimistic. Don’t think SanDisk needs a blow out. A solid quarter would do just fine. At some point soon thereafter expect SSD excitement to start to grow.
No one seems to be talking about SNDK’s Q3 comments on SSDs. Thought they were quite encouraging. Important 2008 milestones will be SNDK’s MLC SSD controller and commercial MLC SSD availability. Both got closer.
According to Judy at the 5 September Citi presentation the controller should be “finished” in 1H08. When pressed, she wouldn’t comment on when commercial shipments would begin, only saying “2008.”
In the Q3 conference call, Sanjay was asked this same question and nonchalantly replied, “we plan to have products ready by mid next year.” June sure sounds better than December. This is a big deal, if SanDisk can deliver.
Eli also had interesting things to say about SSDs. Eli said SNDK expects Flash storage in computing (SSDs),
“to grow nicely in 2008, accelerating in 2009, and by 2010 or 2011, we project that Flash storage in computing could become the second largest user of Flash memory after mobile handsets. We believe that our Flash systems expertise, and in particular MLC implementations as well as our extensive system IP, will become important differentiators in this market as it unfolds over the coming years.”
This is much more upbeat than previous discussions where SSD shipments in 2008 were described as likely insignificant. This is the first I recall SSDs being singled out as having the potential to grow into the second largest flash segment after mobile as soon as 2010/2011.
This is also the first I recall Eli discussing SSD IP. It appears that Eli believes SanDisk controls significant IP for SSDs.
The SSD story is sexy and suspect folks will be looking for SSD plays throughout 2008, especially 2H. SNDK is the obvious choice, but SNDK is going to have to prove it has the right stuff.
In the conference call there was a lot of interesting info on fabs. I’m thinking of devoting a whole weekly post to the subject, so am going to skip it here.
Basically things are going well on the fab front. SanDisk/Toshiba are gaining market share which gives them economies of scale critical for success in the NAND flash industry. It is most important for SanDisk’s prospects that it remain on the leading edge with lowest cost NAND supply. SanDisk and Toshiba are doing this by successfully managing through technology transitions at a rapid pace.
[22 October, SanDisk just announced TakeTV. At the same time, SanDisk also announced FanFare, a public beta of its own internet video download service. The full version of FanFare will be announced early next year with “additional features”. Sounds like SanDisk is gearing up for the big splash at CES in January.]
**** 19 October Analyst excerpts below ****
SanDisk Corp (SNDK)
Margin Leverage Now, Higher EPS Later. Reiterate Buy.
Buy/High Risk 1H
Price (18 Oct 07) US$48.58
Target price US$65.00
Expected share price return 33.8%
Expected dividend yield 0.0%
Expected total return 33.8%
Market Cap US$11,069M
Craig A Ellis
Price Performance (RIC: SNDK.O, BB: SNDK US)
Stock Strategy — Our SNDK thesis has centered on a trade for undiscounted EPS power. The 3Q beat lent support ($0.54 vs $0.32 Street), though capped near term supply and a lower royalty guide produced a muted 4Q07E/2008E Street EPS boost (guidance conservatism also at play) causing the shares to drift off 3% AMC. Modeling $2.76 in 2008E EPS but seeing $3.00 potential, and believing the Street under-estimates 2008 Korean mfgr supply headwinds (200mm de-commissions) but with strengthening demand (SNDK shortage), we stick with the shares on longer-term 2:1 risk/reward, though see potential for volatility in the next 3-4 months ahead of what could be an earlier-than-normal trough in contract pricing.
A Powerful 2Q – EPS was 63% above the Street on royalties ($0.01), product revs ($0.04), GMs ($0.09), opex ($0.03) and other ($0.03). On hand inventory fell 9% qq in dollars and to a lean 7 weeks at retail. Bear concerns about a 16% price/MB decline (CIR -13%) overlook a 10% average density jump.
4Q07 Guide Constrained or Conservative? – New concerns nt include: 1) “constrained” mfg output limiting supply growth to 45-60% (CIR was 70%), and 2) “flattish” royalties (CIR was +26%). Overshadowed was: 1) great product GM trajectory and 4Q07 guidance of 27-30% (CIR was 25.0%), 2) pos NAND S&D implications given huge 54% 3Q bit growth and broader demand backdrop, and 3) Gross margin target attainment and a higher base into 1H08.
CIR Estimates Add Conservatism – Guidance mid-point suggests EPS of $0.60, though we conclude $0.72 is more reasonable (royalty and expense upside). CIR C2008 to $2.76 from $3.00 on lower royalty, higher op ex, but increased pricing and GM conservatism. Expect Street 4Q07 of $0.57 to increase modestly though for controversy to form about upside potential.
Risk/Reward Looks Positive Longer Term – Street 2008 estimates are likely to increase to $2.60-$2.65 (from $2.48), more moderate than we expected. At a better/worse case $2.76/$2.50 in C08E EPS we see downside risk to $44/$40 (16x C08 EPS), though upside to $65 (CIR target). From $48 AMC this suggests risk/reward of 2:1. Milestones are retail sell through, potential positive estimate revisions late-4Q, new products at CES/3GSM, and a Feb-08 analyst day. Risks are contract and retail pricing in 4Q07 and 1Q08.
Positives and Negatives
License revenues of $119M upsided prior $115M guide on SLC premium
pricing and MLC mix at Samsung.
Product revenues of $918M upsided CIR’s $845M and the company’s $750
to 825M guide on better than expected bit growth of 54% (vs 35% est).
Gross margins improved by 740bps to 26.39% (vs 22-24% guide) on
absence of inventory write-offs and a one time insurance payment.
Operating expenses were $12M light of prior 210M guide.
Operating margins YTD at 10.7% exceed company’s 2007E guide of 0% to
3Q07 EPS of $0.54 exceeded CIR/St estimates of $0.34/$0.32 with positive
variance across the income statement.
International sales grew 47% qq to 67% of total product revs.
European retail market share advanced by 350 bps in July and August.
Mobile unit sales accelerated to 41M units, a 36% qq increase.
Inventory DOI to 74 days (from 94 days); channel inventory < 7 weeks.
Gross Margin guided to improve 60 to 360 bps on cost decline benefits
partially offset by fab 4 start-up costs.
Fab 3 achieved full production in 3Q, a quarter ahead of expectations
56nm expected to contribute to 66% of production in 4Q up from less than
50% in 3Q, a positive for 1Q07 cost declines. (Fig 10)
4Q07 demand robust with projected to outstrip current captive supply
Favorable 08E outlook on NAND supply demand balance given 200mm
wafer fab transitions and robust demand from mobile applications.
License revenue guide “flattish” (looks conservative given the 30% contract price moves in 3Q).
Bit growth of 45 to 60% on captive supply constraints below 70% CIR ests and seasonal growth of 84%.
4Q07 operating expense guide of $240 to 250M (23% qq) vs CIR estimates of $208M appears high given prior conservative guide (Fig 5) and focus on managing towards 2008 and 2009E operating margin target of 15 to 18%.
EPS guide of $0.51 to $0.69 moderately above St’s estimates of $0.56
Risk/Reward Looks Favorable
We frame risk/reward with longer term valuation trends. On a P/E multiple basis, the trough is 13.7x, though support is often found near 16x. On a 16x P/E at our $2.76 EPS support would exist at $44, while at more of a worst-case EPS of $2.50 support exists at $40. Alternatively, valuation upside comfortably exists to 25x, which on our $2.76 suggests upside to $69, while at $3.00 in EPS, $75 is possible. On a worst case outcome (low of $40, high of $62) risk/reward looks favorable at 1.5:1, while on a better case (low of $40, high of $68), valuation looks favorable at 2:1. While some will ague the stock’s prospects are done for the year, we remind investors of a substantial late-2005 run that was triggered by increased expectations for handset card sales late-year (SanDisk was supplying the 512MB micro-SD). In our view this supports the view that if expectations for EPS upside forms, the stock can perform well outside a period of typical seasonal strength.
Signposts to Watch Into 1Q08
While the key issue for the stock is fundamentals, signposts along the way will help illuminate if SanDisk is tracking to modeling for the quarter, or if more broadly NAND fundamentals are improving or deteriorating at the margin. Monthly retail sales and product pricing indications along with spot and contract pricing are macro factors to watch. Alternatively, new products impacting 2008 demand expectations will likely emerge more significantly in 1Q08 (January’s CES and Mac World, February’s 3GSM) around the time SanDisk company-specifics come back into focus (January’s results, February’s analyst day).
Estimate Changes – Buffering Our Estimates, Not Ruling Out Upside 4Q07 – While our top line estimate declines 4% to $1.315B as we trim both product and royalty estimates, our EPS declines just 1% given strong gross margins partially offset by higher op ex. As tabulated in Figure 6, SanDisk’s guidance has proven quite conservative in each of the past two quarters. While supply limitations moderate upside potential on the revenue line this quarter, we nonetheless see conservatism in op ex (guided up $40-$50M with half structural, half quarterly advertising/marketing), as well as royalties (we think Samsung pricing will be up meaningfully).
1Q08 – We add protection to our 1Q08 modeling by maintaining a 22.5% gross margin level despite 4Q07’s now higher 28.6% base and by increasing the intensity of 4Q07’s contract pricing to -22% (from -15%).
2008 – Our modeling adds incremental pricing flexibility while moderating bit growth (though 1Q08 should now have an easier compare), and while we credit SanDisk for gross margin target attainment, the company still falls short of hitting its target operating margin in our model.
NAND Supply/Demand Fundamentals – We See 1H08 Much Tighter Than 1H07
We remain positive on the outlook for NAND fundamentals through 2008. Key factors contributing to our positive outlook include:
– An expected tough 1H08 manufacturing transition at Hynix (challenging 60nm transition, move to 48nm adds immersion lithography complexity)
– Significant 200mm capacity obsolescence by end-2008 (Hynix and Samsung 200mm NAND output is 80% and 50% of total production presently)
– Best demand driver year since 2005 forming as high density handsets, video/PMP, and computing ramp in the year
– Risks include 1Q08 seasonality (Street EPS already set close to worst case)
and next gen R&D and capacity investment.
Stock Drivers – Contract Could Trough Earlier Than Normal In 2008, A Positive For A Turn In SanDisk’s Stock Especially If Street EPS Have Upside As We Expect
SNDK’s stock responds to both estimate changes and NAND contract prices (Fig 13). At the margin, the R-squared has increased relative to contract pricing in the past few years, while moderately diminishing relative to underlying earnings trends. (Fig 14).
We note that periods of aggressive pricing (prices are falling rapidly) typically last 3.5 months (Figure 16) and typically not longer than 5.0 months, suggesting pricing could stabilize in the December to February time frame, or earlier than normal given an earlier-than-normal seasonal peak.
We derive our $65 target price (prior $71) using selected forward 12-month price-to earnings, enterprise value-to-sales, and price-to-book value (P/B) multiples applied to C08 estimates. Our target multiples are at a 24% premium to historical medians. We believe selection of a four-year time period is reasonable as it includes periods of supply imbalances (over/under), driven by increasing supply competition, end demand driver growth phases (nano, handsets, USBs), and inventory correction representing a good cross section of NAND industry phases going forward. While our revised multiples are still below the 50 percentile range (of prior 4 year period multiples), we believe a 24% premium to median multiples is warranted to reflect the potential for incremental higher margin royalty revenues, international share gains and margin leverage partially offset by 1H08 seasonality ahead and potential for price declines.
For our P/E, we use a 25x target multiple (trimmed from prior 27x to reflect 1H08 seasonality and contract/retail pricing volatility) applied to our calendar 08 EPS estimate to yield a target price of approximately $69. Our 25x multiple is derived from the company’s four-year historical range of P/E multiples that ranges from 15.1x to 35x. On an EV/S basis, a 2.59x multiple applied to our 2008 revenue per share estimate and net cash gives us a target price of approximately $55. We derive our 2.59x EV/S multiple from a 0.7x to 4.2x historical range. On a P/B basis, our 2.82x multiple gives us a target price of $71. We derive our 2.82x P/B multiple from a 0.8x to 4.2x historical range. Taking the average target price derived from the three methodologies and rounding it, we arrive at our target price of $65.
October 19, 2007
3Q Earnings Beat; While Near-Term Seasonality Issues Linger, 2008 Industry Dynamics Continue to Look Favorable
SanDisk reported solid 3Q results, exceeding our above consensus estimates. Non-GAAP EPS of $0.54 was significantly above of our estimate of $0.38 and consensus of $0.34. EPS upside was driven primarily by robust sequential bit shipment growth, driven by strength in handset cards, USB drives and international share gains, as well as lower than expected operating expenses. Product gross margin of 26.4% came in slightly above our 25.0% estimate and guidance of 20-24%.
Management presented an upbeat outlook for the NAND industry in 2008 — expecting demand growth to outstrip supply growth — and was particularly upbeat about continued demand growth from handsets. This supports our view that industry supply-demand dynamics should improve in 2008 versus 2007. SanDisk’s indication of its plan to increase the percentage of non-captive supply in 2008 should also help alleviate some of the market’s fears about Toshiba/SanDisk’s supply growth.
We are adjusting our 4Q non-GAAP EPS from $0.71 to $0.64 primarily due to higher operating expenses and to a lesser extent, SanDisk’s capacity constraints which may potentially limit bit growth. For 1Q08, we believe seasonality could possibly be less pronounced than in past years, driven by a continued increase in handset card penetration, and for SanDisk specifically, seasonality could also be softened by further international share gains. We also continue to expect a meaningful recovery in SanDisk’s product gross margin in 2008 to lead to solid earnings growth for the company.
We believe investors should look beyond 1Q08 seasonality as we believe upside potential for the stock – driven by better 2008 industry fundamentals versus 2007 – significantly exceeds downside risk. We believe downside risk is to the mid-to-low $40s and that near-term seasonality issues are getting priced in to a certain extent. In our view, upside potential is to the high $60s. We are maintaining our Outperform rating and $68 price target.
SanDisk reported solid 3Q results, exceeding our above consensus estimates. Non-GAAP EPS of $0.54 was significantly above of our estimate of $0.38 and consensus of $0.34. EPS upside was driven primarily by robust sequential bit shipment growth, which increased 54% compared to our estimate of 34%, driven by strength in handset cards, USB drives and international share gains, as well as lower than expected operating expenses. Product gross margin of 26.4% came in slightly above our 25.0% estimate and guidance of 20-24%, though was helped somewhat by a one-time insurance claim.
Management presented an upbeat outlook for the NAND industry in 2008 — from a demand perspective, the company expects continued strength in demand growth from the handset segment from both a unit and density perspective, as flash penetration rates remain low and densities are growing rapidly – and expects demand growth to outstrip supply growth next year, helped in part by some retirement of 200mm capacity. Management’s comments support our view that industry supply-demand dynamics should improve in 2008 versus 2007, with a moderation in supply growth. SanDisk’s indication of its plan to increase the percentage of non-captive supply in 2008 also should help alleviate some of the market’s fears about Toshiba/SanDisk’s supply growth. For full-year 2008, we are forecasting SanDisk’s ASP to decline by 53% YoY, versus 62% in 2007.
We believe 1Q seasonality could possibly be less pronounced next year, driven by continued increase in handset card penetration, and for SanDisk specifically, seasonality could also be softened by continued international share gains. We continue to expect a meaningful recovery in SanDisk’s product gross margin in 2008 to lead to solid earnings growth for the company. In addition to a more benign pricing environment, margins should benefit from the 56nm transition near-term, the move to the 43nm node from 2Q08, as well as the gradual shift toward 3-bit-per-cell production. We are adjusting our 4Q non-GAAP EPS from $0.71 to $0.64 primarily due to higher operating expenses and to a smaller extent due to SanDisk’s capacity constraints potentially limiting bit growth.
While it is difficult to get excited about near-term NAND market trends, we believe investors should look beyond 1Q08 seasonality as we believe upside potential for the stock – driven by better 2008 industry fundamentals versus 2007 – significantly exceeds downside risk. We believe downside risk is to the mid-to-low $40s and that near-term seasonality issues are getting priced in to a certain extent. In addition to the industry outlook for 2008, we expect SanDisk to continue to gain share in the global flash card market in upcoming quarters, and see solid cost reductions driven by its various technology transitions. We are maintaining our Outperform rating and $68 price target.
October 19, 2007
SanDisk Corporation (SNDK)
Q3 great; guidance just okay; valuation now reflects supply risk
SanDisk reported strong Q3’07 results. Sales of $1,037mn (+25% qoq), were significantly above our $920mn (+11% qoq) estimate. 3Q’07 pro-forma EPS of $0.44 was $0.26 above our $0.18 estimate (including ESOs) and $0.20 above the Street (including ESOs). Significant EPS upside was driven by higher sales, a significantly higher gross margin, and lower expenses. Bit shipments were +54% qoq, while ASPs were -16% qoq. Guidance, while disappointing relative to the most bullish expectations, was still comfortably above the Street and is likely conservative (especially the royalty forecast). Our CY07 EPS is increasing to $1.28 from $0.94 given the robust Q3’07 results. Our CY08 EPS remains unchanged at $2.50.
We continue to believe there is a good near-term trading opportunity and SanDisk remains on the Conviction Buy list as: (1) the near-term fundamental environment is very strong as the company does not expect to be able to meet all of the anticipated Q4’07 demand, (2) valuation is attractive at a significant discount to our sum of the parts analysis or on a more traditional multiple of ’08 EPS, even modeling in significant ASP erosion for next year, and (3) SanDisk’s long-term growth drivers remain intact. Near-term trading will remain choppy until current weak spot market trends stabilize. The market will also remain concerned with traditionally weak Q1’08 seasonality, but we believe the current stock price reflects these risks as the stock is barely trading above early ’07 levels when SanDisk was losing money and before Hynix was announced as a licensee.
Our 12-month price target for SanDisk remains $65. Our price target is based on a fair value for royalty sales of ~$46, ~$9 in net cash/share, and an 20X multiple on 2008 product EPS (ex interest income) of ~$0.50.
The key risk to our view is incremental NAND supply coming on-line.