Bernstein SNDK 60
After a series of serious setbacks SNDK has reset back to the mid-$30s partly due to a crisis in confidence and partly due to a far worse oversupply and pricing situation in NAND than we earlier anticipated. In this note we look at what we got wrong and why, and evaluate support levels for the stock.
? SanDisk management have now given us a triple whammy of increasingly negative guidance that has spooked investors, sending the stock down 35%: First on January 25th when they guided lower than expected Q1'12; Second on April 3th when management pre-announced that Q1'12 would miss guidance; And third on April 19th when the company confirmed poor Q1'12 results and guided even worse Q2'12 ASPs and gross margins.
? So what did we get wrong? We attribute this miss to the entire NAND industry overshooting supply and underestimating 1H'12 demand weakness, which was exacerbated further for SanDisk by unfavorable product and customer mix.
- During Q4'11 all NAND suppliers announced plans to put on hold all further capacity expansion plans, correctly anticipating a potential oversupply situation developing in 1H 2012. However, it took too long to put the brakes on, with suppliers continuing to add capacity through Q4 2011 and part of early Q1'12. We believe this was due solely to companies completing their current fab build plans and that fab expansion has now halted for all companies except Hynix which plans to add 40kWPM by the end of 2012 (less than 4% of industry supply).
- This supply overshoot was exacerbated by demand weakness worse than expectations in Q1'12. With high-end flagship smartphones past major build cycles and waiting for next generation releases and Ultrabooks not kicking in until 2H 2012, we saw no demand drivers. While Q1 generally does have the lowest demand in the year, in 2012 this seems to be exacerbated by smartphone and ultrabook product cycles, which in turn is related to availability of quad-core application processors, Intel's Ivy Bridge platform, and to some extent Windows 8.
- While SanDisk's product mix is the most profitable in a stable market, it is also the most volatile in a down cycle. This recent oversupply has hit SanDisk harder than competitors as SanDisk still has the majority of its business in removable flash (cards and USB flash drives), and its embedded business had too much exposure to HTC, RIM and Nokia, all of which have been struggling and losing share. As removable flash suffers the most in downturns, all of this culminated in a perfect storm for SanDisk. They had too much product with not enough demand and so were forced to dump cards in the channel, which has created bloated card inventory and hence falling prices for cards.
See Disclosure Appendix of this report for important disclosures and analyst certifications.
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May 22, 2012
Mark C. Newman (Senior Analyst) • mark.newman@bernstein.com • +852-2918-5753 ? We continue to believe that margins will recover in 2H 2012 and 2013, but today's analysis shows
that SanDisk's prices and margins may be even worse than our projections and company guidance.
- Our previous estimates were that SanDisk's ASP would be down 21% QoQ for Q2'12. While we see that NAND contract prices are within this range and in fact trending better, we note that flash card spot prices have fallen faster. Although flash card spot prices are not totally indicative of SanDisk's actual price, we use these as an indicator and estimate that SanDisk ASP for Q2 could be down 22% to 26%.
- We do however continue to believe that as demand rebounds, prices will stabilize in 2H'12 and 2013. SanDisk ASP will be much more volatile on the upswing than competitors for the same reason it was more volatile on the downswing, and hence we expect SanDisk may recover faster than expectations.
? SanDisk is currently trading at below liquidation value, which we estimate at $33 per share. Our $60 target price is based on 10.4x 2013EPS or 7.7x 2013EPS plus net cash.
- For the $33/share liquidation valuation: We calculate net cash at $15.57/share; Royalty at $13.52/share for the bear case; And the JV assets subtract debt would capture $3.98/share in a fire sale (see Exhibit 10 to Exhibit 14).
- Currently SanDisk is trading way below comps and the SOX on both a P/B and P/E basis, especially ex-Royalty and ex-Cash (see Exhibit 18, Exhibit 19).
- For the $60/share target price: Net cash is $15.57/share; Royalty at $17.97/share; And the Product business is valued at $26.46/share.
Investment
Conclusion
We rate SanDisk Outperform with a price target of $60. We believe that NAND is an attractive industry unlike what DRAM has been for the last decade or so, due to more favorable industry dynamics and strong growth drivers such as smartphones, tablets and SSDs. Although 1H 2012 has seen oversupply we forecast NAND demand growth to outpace supply, bringing the industry back in to balance within 2H 2012. This will enable firmer pricing and margin recovery for all players. In particular, we believe SanDisk is well positioned to enjoy profitable growth in this industry due to its technology leadership in controllers and is attractively valued at these levels. |
