SanDisk Corporation’s share price plummeted after rallying over 10% since the beginning of June after Q2 numbers were released on Wednesday. It is very painful to see the stock hand back over a month of gains but the stock apparently had gotten more than ahead of itself and a sell-off pursued throughout after-hours trading on Wednesday. The stock was down 13.5% off of Wednesday’s close by market close on Thursday. We thankfully got about 1.5% of this back on Friday but still lost quite a bit of gains. To be fair the stock did partake in a rather extensive rally leading up to earnings, probably due to high expectations from traders.
SanDisk beat on both the top and bottom lines but the source of the sell off was a result a drop in gross margin. The company posted revenues of 1.634 BB USD above consensus of 1.6 BB and an EPS value of 1.41 dollars per share above consensus of 1.39 dollars per share. Revenue growth was 10.7% YoY compared to EPS growth of 8% YoY. Gross margins were 48%, right in the middle of what the company had guided last quarter. There were no real surprises here, the company landed right around where they had guided and above consensus. The drop in margins from 51% to 48% non-GAAP is definitely worrisome but they had guided in the 47-49% range. This is being attributed by many analysts by Apple’s bargaining power. Apple contributed 20% of SanDisk’s revenue in 2013. SanDisk’s average selling price per gigabyte dropped 16% whereas cost per gigabyte fell by 12% QoQ, resulting in a 3% drop in gross margins. We believe that the stock is still a great longer term investment but a short term drop was inevitable after seeing the company up around 45% in four months. In an industry where oversupply has been an issue time and time again we have finally reached a point where demand is outpacing supply for NAND flash memory. This is going to throw more fuel onto SanDisk’s double digit revenue growth and should also help them retain pricing power going forward. Longer stays at each technology node will also increase the life of key intangible (patents) and tangible (manufacturing equipment) assets and provide time to prepare for technology ramps.
CEO Sanjay Mehrotra provided clarity on the results & outlook with the following points,
- Increasing attach rates for of SSDs to notebook computers, currently at 30% and expected to increase to 60% by 2017. This implies an annual growth rate of about 32% in PC SSDs if PC sales are flat. Strong results and guidance from Intel Corporation suggest PC growth may be in the cards.
- Slight embedded solutions growth and a higher mix of “custom embedded solution" sales.
- Revenue ramp from X3 products for mid and entry level smartphones in China, the fastest growing areas of mobile, are expected in 3Q 2014.
- The 1Y technology node accounted for 60% of bit output and is expected to remain at this level for the remainder of 2014.
- Enterprise SSD growth 30% sequentially and over 100% YoY. SSD solution mix came in at 29%.
- 15 nanometer production will ramp at the end of the year, 3D NAND pilot lines in 2H 2015.
This statement stuck out to me as the most alarming object from the release.
“We expect approximately 5% wafer capacity growth in 2014, and given OEM and enterprise demand for 19-nanometer supply, we expect our supply bit growth to be at the lower end of our previously stated range of 25% to 35%. Our estimate of industry supply bit growth remains at approximately 40%.”
Sanjay went on to discuss “supply constraints” arising from strong demand for sub 1Y, 19-nanometer technology.
This makes it sound like SanDisk is losing market-share and that demand for more advanced technology nodes is progressing slower than the company had forecasted. While Q3 will be weak due to these supply contraints, the tides will turn as technology ramps progress and capacity is added. The discipline to limit capacity growth is comforting as well because an oversupply situation would be drastic.
Comments from CFO, Judy Bruner
§ SSD solutions up 97% YoY 9% sequentially
§ Removable products up 7% YoY & sequentially, especially strong micro sd card growth in emerging markets.
§ Embedded revenue down 29% YoY and up 3% sequentially, reportedly due to in progress qualification for iNAND solutions with “several” customers.
§ Operating expenses of $311 MM were slighting below company forecasts.
Conclusions & The Acquisition of Fusion-io
The industry outlook is still an extremely compelling reason to stay in the name but another main reason that we upped our price target was the acquisition of Fusion-io for $1.1 BB. This purchase is expected to be accretive by the second half of 2015. This acquisition will give SanDisk more access to the enterprise SSD market, its fastest growing business, along with access to more sales from some big customers including Cisco, Dell, HP, Facebook, IBM and Apple. They got the company for right about 2 times its book value, which seems like a steal when the company actually posts higher gross margins than SanDisk, coming in at over 51% GAAP in the last reported quarter. We believe that Sales & Marketing coupled with Research & Development synergies will allow this acquisition to generate income within a year. The company still trades at 19x TTM earnings and 16x 2015’s earnings before considering the acquisition. This company is making an amazing transformation into a tech heavyweight in storage and is increasingly more shareholder friendly with dividends and share repurchases. There is still a lot of room to run here despite this short term correction. SanDisk will not have to beat consensus next quarter by more than a couple cents in order to avoid another pullback. This pull-back surely has taken guidance for next quarter into account. Our estimates have the company beating consensus by a few cents next quarter and by above ten cents in the fourth quarter. We would be encouraged to sell in the face of further margin deterioration and revenue growth in the single digits beyond next quarter. While revenue growth is expected to be unimpressive next quarter, the bar is low and we expect the double digit YoY revenue growth to continue in 4Q and beyond. The company is cooling off a little bit and recharging and we think extending the position into 2015 will prove beneficial.