And so it begins.
According to LCM’s Asia Tech Tour report of 25 June 2010, both Toshiba and Hynix have customers on allocation. There just isn’t enough NAND to go around.
Apparently Toshiba can only supply its major retail customers with about 70% of what they want.
As LCM’s Dan Amir put it, “We have learned that, in the past few days, Toshiba decreased the amount of NAND allocated to its major retail customers by 10%+ for 3Q. Most players can get only 70% of their total order from Toshiba for 3Q. Toshiba explained that demand is very strong from handset OEMs and Apple. Hynix is also starting to put some of its customers on allocation.”
Excerpts from the LCM report are included at the end of this post.
This has lots of implications for SanDisk. All of them good.
The stars seem aligned for profitability driven by unprecedented strength in pricing underpinned by surging demand and constrained supply.
Demand appears to be driven primarily by smartphones and tablets, where both embedded and removable NAND products are the only game in town. Predictably Apple is leading the way.
Apple’s iPhone 4 and iPAD are setting the pace. Both are NAND-based and huge successes. Amir notes that Apple itself now consumes 25%-30% of the total NAND supply in the world.
As competitors scramble to catch up, NAND is getting scarce. And there are no alternatives.
Back in the Q1 conference call Eli delicately and accurately described the allocation scenario now emerging, when asked about OEMs pre-buying an anticipation of a shortage in the back half of the year (now):
“ Let me answer it without, indirectly. We do feel that you’ve heard me say or us saying that in the next decade we think that flash will be bigger than you think and that’s really based on the mobile and the way it’s going as well as the SSDs.
Two major new markets that are very, very early, so the industry will need to build additional capacity that doesn’t exist. I think we all know that. And you know the key is really the timing of those because the return on investment by itself is tied to the timing.
Now, what that leads me to say is over the next several years there will be periods, I believe, of shortages of flash memory, and there will be times where people will understand, OEMs, particularly large OEMs, that flash is becoming very strategic to their business. You can view it as a commodity, but when you can’t get it at any price because it is just not there because your demand far exceeds the available capacity of the industry, and the cumulative demand of all customers, then of course people will start wanting to secure for themselves some of that capacity, so I do expect some of that may happen.
Of course we don’t know for a fact, but I would not be surprised if the strategic nature in the next few years is going to start becoming effective. It’s no secret flash is a very, very tough technology. There are very few companies that can really deliver leading-edge technology, very high volume, both from the technology and the manufacturing and the balance sheet. So the answer to your question is yes. I think there is going to be some of that but there are some OEMs will start taking steps to assure themselves of supply.”
If supply is as tight as it appears to be, OEM customers really have no choice but to pre-buy in order to assure themselves of NAND supply.
If SanDisk doesn’t discuss pre-buying in the upcoming conference call, I expect analysts to press the issue and, when pressed, for SanDisk to answer yes.
The big deal about pre-buying and allocation is that it is indicative of demand outstripping supply. Such strong demand means strength in pricing.
Stronger pricing translates to both higher revenues and stronger gross margins. As a bonus L&R revenues will get a boost too.
How this translates for the rest of this year and next, should be an interesting story to watch unfold as analysts scramble- playing catchup.
Looking at earnings estimates, I don’t think the street quite gets it yet.
The average SanDisk estimate for Q2 is $0.89 EPS; for 2010 as a whole its $3.82. Most remarkably, the average 2011 estimate is $3.64.
Personally I expect Q2 to be well over $1.00; 2010 to be closer to $5.00 than to $4.00 and 2011 to be over $6.00 EPS.
Significant new NAND supply looks like a second half 2011 story at the earliest. Even then, additions look modest. The latest BoA/ML report notes that Samsung seems to be planning on dedicating its currently available clean room space to DRAM and logic rather than NAND.
To significantly ramp it’s NAND supply, Samsung will need a new fab. New fabs take years and billions of $$$. See BoA/ML report excerpts below.
It appears that NAND flash is starting to swing from commodity to a strategic material. Not a problem for SanDisk.
**** excerpts from the LCM 25 June 2010 report ****
Lazard Capital Markets
June 25, 2010
SNDK: Asia Tech Tour – raising SNDK estimates, price target to $59 from $52 on favorable NAND data points; BUY
On day 4 of our tech tour we have met players in the NAND market and collected data that make us even more bullish on SanDisk.
Toshiba beginning allocation. We have learned that, in the past few days, Toshiba decreased the amount of NAND allocated to its major retail customers by 10%+ for 3Q. Most players can get only 70% of their total order from Toshiba for 3Q. Toshiba explained that demand is very strong from handset OEMs and Apple. Hynix is also starting to put some of its customers on allocation.
Allocation leading to price increases. Our checks suggest that prices for July, which is traditionally a slow month, are expected to increase by 3%-5% on the spot market and contract price is expected to be at least flat. Players in the industry believe that 3Q supply will be tight and are preparing for price increases throughout the quarter. We believe that the sudden success of Apple’s iPad and the launch of the iPhone 4 is resulting in increasing demand for NAND flash. Apple now consumes 25%-30% of the total NAND supply.
Retail market starting to pick up. After a fairly slow 1H in the retail market, demand is beginning to pick up. Module houses in Taiwan expect a more normal demand pattern in 2H, with revenue +20%-25% Q/Q in 3Q. Despite the increasing 3bit supply, we continue to believe that supply will be fairly tight for the retail market in the near term, though stronger than we previously anticipated.
Data points very positive for SNDK. We believe that the increased tightness of NAND in summer and the pick-up of demand at retail is very favorable for SNDK’s vertical business model. We continue to see SNDK as a good derivative play on the success of Apple, leading to very strong 2H GM and sales beating Street ests. We are raising our 2Q forecast to $1.2B/$0.93 from $1.14B/$0.85 and 2010 to $5.1B/$3.92 from $4.7B/$3.48. We are raising our target to $59 from $52, based on 15x our new 2010 EPS estimate. Biggest risk is retail demand.
We like SanDisk for the following reasons: 1) The company is well positioned in terms of cost-downs in 2010 with the transition to 32nm and 3bit and will likely see cost-downs of ~40%, better than ASP declines of ~32%. 2) The stronger- than-expected NAND environment in 2H10 is positive for SNDK’s vertical model. We continue to believe that the Street might be underestimating the strength in the OEM channel, which is driven by tablets/e-books and smartphones. 3) We believe that the company continues to gain share with its product variety and pricing flexibility, especially in the private label segment. 4) The mix-change toward OEM should provide longer-term stability and opportunity for new revenue streams. Our new price target of $59 is based on 15x our new 2010E EPS.
**** excerpts from the BoA/ML 15 June 2010 report ****
Business environment more favorable; PO up 18% to $60
Bank of America/ Merrill Lynch
Simon Dong-je Woo, CFA
Merrill Lynch (Seoul)
Merrill Lynch (Seoul)
ASP better, lower Samsung threat; PO up 18% to $60
We raise our PO from $51 to $60 (27% upside potential) for three reasons: 1) EPS revisions (+22/13% for 2010/11E); (2) Samsung’s potential constraints in NAND capacity ramp-up (lack of shell fab); and (3) solid chip-pricing environment. Our ASP assumption changes already indicate 33% higher operating profit in 2Q (ASP: -8% QoQ vs -15% previously; OP: $319mn vs $240mn). This suggests upbeat 2Q results to us (OP consensus: $301mn). Our new 2010-12 EPS estimates are far higher than the 2005 peak ($3.5-4.0 vs $2.0), which we believe is not yet reflected in the share price ($47 currently vs $80 in early 2006). Our PO is derived from 16x P/E, 2.3x P/BV and 7.5x EV/EBITDA based on 2010-12E, which is close to the historical average to be conservative, despite the all-time high earnings. We reiterate our Buy
NAND pricing momentum has been upbeat
Quarter-to-date NAND chip and card prices have been far better than seasonality (mid-single-digit drop QoQ in 2Q vs normal: high-teen decline). Solid demand from smartphone and iPad has well absorbed supply growth. Further, Samsung’s logic-chip capacity expansion at the expense of NAND fab clean room should be a positive for SanDisk. Overall, we project better-than-normal NAND-chip-pricing momentum, at least in 2H10-1H11 (ASP falls less than cost).
SanDisk remains one of our global top picks in memory
SanDisk has been one of the best-performing memory stocks YTD (+63% vs Micron -16%, Samsung 0%, Toshiba -8%). Apart from an upbeat NAND price and Samsung’s less aggressive NAND move, we see four potential positive catalysts: 1) technology leadership (better than Samsung in our view); 2) stable royalty revenue (Samsung is the biggest payer); 3) benefit from NAND JV fabs with Toshiba (cost competitiveness for cards); and 4) healthy balance sheet (net cash).
SanDisk should be a major beneficiary of the NAND industry recovery. NAND capex spending among chipmakers has been abnormally low in 2009. We expect this to lead to a NAND shortage and new business opportunities for SanDisk, through the leverage of its well established JV fabs and options to use Samsung capacity – the JV fabs were company-specific weaknesses during the NAND downturn. We expect 2010-11 profits to exceed the previous highs of 2006-07, but still remain below the 2005 peak.
Best-performing memory stock
SanDisk has been one of the best-performing memory stocks YTD (+63% vs Micron -16%, Samsung 0%, Toshiba -8%). The key potential positive catalysts as we see them are: 1) technology leadership (better than Samsung in our view); 2) stable royalty revenue (Samsung is the biggest payer); 3) better-than-expected NAND and card-pricing momentum (cost advantage from captive chip production capacity via JV fabs with Toshiba); 4) Samsung’s potential constraints to expand NAND chip production capacity (currently available clean room space among Korea and US fabs will be used for DRAM and logic in our view – see our note on Samsung’s logic capex increase, which will likely hit NAND wafer capacity ramp- ups); and 5) a healthy balance sheet (net cash).
We believe these factors will continue to lead to SanDisk’s share price outperformance as a pure NAND play coupled with solid earnings momentum. We raise our PO from $51 to $60 following +22% and +13% EPS revisions for 2010-11E. Our PO factors in just the historical average of fair multiples based on 2010-12E earnings (16x P/E, 2.3x P/BV and 7.5x EV/EBITDA), despite the all- time high earnings. We reiterate our Buy rating on SanDisk as a global top pick in the memory chip sector.