SanDisk Corporation pulls back drastically after an amazing four month rally

       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.

WWW 2nd Quarter Earnings

Wolverine World Wide reported 2nd quarter earnings before the market opened on July 15th, 2014. They reported earnings of $.31 per share beating estimates by over 14% while having sales come in at $614 million, just .77% above street estimates. This illustrates Wolverine's ability to increase margins during a tough retail environment focused on increased promotional activity. Although Wolverine increased margins leading to higher earnings, the stock still fell just over 3% today due to expected costs that come along with their "strategic realignment plan". Here they have unveiled their plan to close 140 stores by the end of FY 2015 with 60 of these coming by the end of 2014. The costs of the realignment plan are expected to be between $30 - 37 million between now and the end of 2015. This will lower EPS over the next 6 quarters but is the right move for the company going forward. Many of these planned closures are from one of the recently acquired and under performing brands, Stride Rite. They have also agreed to end their licensing agreement with a small brand from the performance group, Patagonia, that has generated small revenue and rarely contributes to their profit.

Retail has struggled mightily throughout the year and Wolverine is no exception. But while many company's have relied on promotions to drive traffic at the expense of lower margins Wolverine has instead experienced margin expansion. Through their "strategic realignment plan" they plan to consolidate certain consumer direct functions and experience additional synergies that will continue to drive margin expansion. Wolverine has continued to navigate this increasingly difficult retail environment head and after updating the model still has a potential upside of 19% from our original purchase price, $27.30, and a 27% upside from today's closing price of $25.64. While I believe this company has high earnings and stock price ahead of them I will continue to monitor them and watch for if they drop below their stop loss of $24.57 which would represent a 10% drop from our original purchase price.

Citigroup Q2 Earnings

Citigroup reported second quarter earnings before the market opened on July 14^th, 2014.  The bank also reported settling with the government for a $7 billion fine.  The bank took a pretax hit of $3.8 billion this quarter, which led to revenue of $19.34 billion but a profit of $181 million ( 3 cents  a share).  Excluding the one-time legal fees, EPS was $1.24, topping estimates of $1.05.   

Citi reported a 15% drop in overall trading revenue, much less than the 25% anticipated by CFO John Gerspach. This was aggregated from a 12% drop in Fixed Income trading, and a 26% drop in equities. But investment banking revenue jumped 16%, driven by an increase in debt and equity underwriting. As like Wells Fargo earlier in the week, Citi was hurt by low mortgage originations.  They continued to benefit from stronger credit quality, with cost of credit dropping 15% year over year. 

                On the earnings call, the CFO noted it’s continued effort to re-size retail operations, with the closing of 70 branches.  Retail services revenue was up 7%.  He said Citi is expecting to see substantial revenue growth in the second half of 2014. 

The company also managed to cut costs by 3% year over year, as CEO Michael Corbat continues to be successful in his streamlining and cost-cutting initiatives.  Another positive note, Citi realized its first profit in Citiholdings, where it’s bad assets are stored.  The amount of the $244 million gain compares to a $591 loss a year earlier. 

                As the second bank to make a deal with the government, Citigroup avoided a long and costly court battle.  They also closed the book on any litigation from subprime mortgage backed securities, and credit default obligations.  The bank will pay $4.5 billion in cash, and another $2.5 billion in consumer relief.  The $7 billion is higher than Citi offered, but much lower than the $12 billion seeked by the Justice Department.

The stock rallied $1.42 or 3.02% on the day.

Solarwinds Inc. Double Down - Pullback Breeds Opportunity, ~30% Upside Potential

This past Friday we doubled down on Solarwinds Inc. buying 78 shares at 38.23.  With strong support at $37.00 confirming upward momentum the short-term technicals validate an entry while the long term fundamentals remain intact. We see appreciation potential of over ~30% from current levels.  Solarwinds continues to generate outsized free cash flow to fund M&A activity. Notably they recently acquired Pingdom, which will allow the company to shift performance management from on-premise technology to the cloud. With strong focus on international sales expansion and management actively seeking acquisitions to expand its product portfolio Solarwinds offers opportunity at these current levels. Compelling historical revenue growth rates, margins and a deep loyal customer base of Information Technology professionals help us confirm the assertion. As we look for EBIT to normalize in 2014 after considerable investments were made in the business during the past year we believe further revenue streams will be unleashed. Particularly regarding cloud security management. Furthermore, Solarwinds continues to drive deeper penetration with its existing client base as most of its revenue, 62% is reoccurring. Solarwinds is a strong company with a compelling growth story. We are maintaining a $52.00 PT, which represents a 29x multiple to our FY14 EPS estimate of $1.70 vs street consensus of $1.64. Currently the stock is trading at 33.5x times, slightly cheaper than historically at 36x times. In conjunction with the company’s profitability and earnings potential we see significant upside appreciation and reiterate a BUY rating.

ROSE -5.15%

With the energy sector as a whole being down almost 2% today, Rosetta Resources took a 5.15% hit in todays trading. This was expected out of energy stocks sooner or later, and especially E&P companies. One reason is the recent "tear" this stock has been on due to turmoil around the world specifically in Iraq, with oil prices spiking over the last weeks companies like ROSE are inclined to pump out more oil than normal which attracts investors. We saw an example of this with the recent large appreciation in stock price. With no overwhelming bad news on the stock, I believe this 5% dip is just investors collecting their profits with the recent upside we've witnessed. With this being said, our investment thesis is still in tact and theres no urgent action to be taken on the stock.

Double Down On Citigroup

     Back in March I decided to cut Citigroup to a half position because of the uncertainty regarding it's capital plan rejection.  Although a raise in dividends isn't likely until 2015, it's rejection has largely unaffected the stock, and now there is an opportunity to regain the full position.
On Friday news came out about the pending investigation into Citigroup's part in writing shoddy mortgage backed securities.  Citi offered $4 billion to resolve the allegations, but the justice department is looking for $10 billion.  They also disagree on the severity of Citi's involvement.  Citigroup claims it shouldn't owe nearly as much as the other large banks (BAC, JPM) because it's net dollar amount of sub-prime MBS was a fraction of the amount written by the other large banks (a couple hundred billion less).  The stock dropped 1.4% representing a nice buying opportunity.

Although there are a few headwinds in front of Citi (Mexico fraud, MBS allegations) none of this has affected the ongoing business of Citigroup.  Also, my thesis is intact. Citi performed well in Q1 posting earnings which beat estimates, and cut back expenses above my expectations which should continue moving forward.  They've continued to decline their bad assets in Citiholdings, which has been a drag on earnings.  And volatility has returned to recently calm markets, so trading revenue for the big banks shouldn't decline as much as expected.  Citigroup is set to outperform.

For these reasons, along with the stock being at $47.59, (two cents above original buy-in) I believe we should initiate a full position.

NOV -9.5% premarket

After completing its spinoff of its independent distribution business, ticker DNOW, NOV took a hit in pre market trading this morning, down as much as 9.5%. Clay Williams now holds the executive chairman position with NOV being that Merrill Miller Jr., the previous executive chairman stepped down and holds the same position with the new publically traded company DNOW. Today is the first day NOW will be traded on the stock exchange. As for NOV being down quite a bit in pre markets, I believe it is a over reaction by the investors with the change that is taking place today. I don't think this is a reason to get out of the position just yet and am expecting a quick recovery of the stock price. I will report back to the group when I have more information about this situation for any further action. Thank you.