Thanks for the Memory

04/25/2012 10:15 am EST

Focus: STOCKS

This memory company has been one of the leaders in memory development for decades, but the recent global economic slump has meant the stock has been floundering. Is this a buying opportunity? Paul McWilliams of Next Inning Technology Research weighs in.

Even before SanDisk (SNDK) lowered its first-quarter guidance on April 3, my stated thesis was we could see the price drop into the low $40s during the first half before new demand drivers materialized during the second half.

We got the low $40s following the lowered guidance, and now with SNDK's forecast for further declines in the Q2, we'll likely open in the mid-$30s. That means if we go through a summer slump in tech, we could see the price of SNDK dip to the low $30s or possibly even the high $20s.

The short story here is nothing new for the memory market—there was an imbalance in supply and demand (too much supply and too little demand). Demand when measured in bytes shipped was down 4% sequentially, which is more or less in line with (or somewhat better) than aggregate seasonal expectations. On a year-over-year basis, demand was up 65%.

However, average selling prices (ASP) declined 22% sequentially and 44% year-over-year. Due to the fact costs only declined 11% sequentially and 36% year-over-year, profit margins were down from last quarter and from last year. This resulted in non-GAAP earnings of 63 cents, versus expectations of 69 cents.

SNDK expects a continuation of this trend in Q2, and forecasts revenue will be only about $1 billion. When you figure in the forecasted gross margin and expenses, the bottom line calculates to be 17 cents in non-GAAP earnings per fully diluted share on a non-GAAP basis. That is substantially below the 82-cent consensus.

During the second half, however, SNDK expects a reversal in the trend and "strong" sequential growth during both Q3 and Q4. The drivers SNDK pointed to during its conference call were in perfect alignment with the second-half drivers shared in our recent State of Tech report:

  • Next-generation UltraBooks sporting the new Ivy Bridge processor will frequently use either an Solid State Drive (SSD) or a hybrid drive that combines NAND Flash with a hard disk drive (HDD). SNDK is well positioned to participate in both configurations.
  • SNDK believes smartphone sales will accelerate during the second half.
  • The release of Windows 8 will drive new tablet demand.
  • SNDK will begin shipping its new PCIe enterprise-class SSD during Q2.

In addition to these drivers, SNDK noted that even on a sequential basis, there was an increase in demand as measured in bytes sold in emerging markets. Even though sales into emerging markets is dominated by smaller than average memory cards, this is a very positive trend that should benefit SNDK going forward.

At the bottom line of our State of Tech commentary on SNDK, I wrote the following:

"Trading still in the mid-$40s, SNDK clearly is not a hated stock today. While I normally don't like to buy memory stocks until everyone hates them, I think unless we see a major macro-event that substantially alters the course of the world economy, we'll see a notably better market for NAND Flash in the seasonally stronger second half and, with that, an opportunity to sell inside my target range.

"While I continue to think this will work out successfully, I would probably plan an earlier exit in the very high $50s to avoid the risk of SNDK breaking its next (and stronger) resistance point at $60."

When the price of SNDK dropped to the low $40s following the publication of that report, a reader wrote to ask if that meant SNDK was now "hated" by Wall Street. The short answer is, "not by a long-shot." When memory companies are hated the price drops to nearly (and in some cases below) balance sheet value. For SNDK today, that would mean something in the mid to high teens.

While I don't see that on the horizon unless there is a substantial decline in worldwide economic activity, I certainly wouldn't rule out a dip to the low $30s or high $20s if tech stock prices dip significantly this summer. That said, if the second half pans out as I noted in our State of Tech report, and SNDK forecasted during its April 19 conference call, I continue to believe there is good upside potential.

However, since the price will clearly start from a lower base than I had anticipated, I would lower the exit target from the high $50s to the mid-$50s, and view the near-term risk at the current price level as being fairly high.

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