Kalra on SANDISK CORP
(SNDK-$56.11-Outperform)
Raising 3Q EPS; Stock Should Continue to Appreciate
• As investors watch the decline in spot and contract NAND pricing, they are nervous about
SanDisk's 3Q ASP. Our channel and price checks actually point to slightly better than
expected ASP for SanDisk versus guidance. Based on our analysis of SanDisk’s retail pricing,
we estimate its overall ASP for 3Q should decline by 17% QoQ, assuming a 13% MoM
decline in its September retail prices.
• We are raising our 3Q revenue from $705M (-2.0% QoQ) to $720M (+0.2% QoQ), based on
an increase in our ASP estimate from the guided level of 19% QoQ decline, to a 17% QoQ
decline, and our product gross margin estimate from 35.0% to 35.5%, above guidance of 33-
35%. Our 3Q EPS goes from $0.54 to $0.56, above consensus of $0.53.
• The key reason for above-consensus 3Q and 4Q EPS estimates ($0.56 and $0.94 versus $0.53
and $0.75) we believe is our higher GM assumptions. In light of the various cost drivers -
300mm ramp, 70nm transition, lower non-captive supply - we believe SanDisk’s 3Q margin
guidance was conservative, and that the street is also underestimating SanDisk’s GM potential
for 2H06.
• We would remind investors that 3Q is a highly back-end loaded quarter, and that the seasonal
peak for flash demand is still ahead of us. Demand from MP3 players will pick up in
September and should be a key driver of demand growth through November, and we expect
SanDisk to have a strong 4Q for handset cards, where demand has been picking up rapidly in
recent weeks.
• SanDisk stock has clearly outperformed the market in recent weeks (up 50% from the trough
in July). Despite this move, we see significant near-term upside and reiterate our $68 price
target. We believe the stock has yet to fully price in the gross margin upside and earnings
potential for 2H06. Moreover, we believe we are at a turning point for flash supply-demand
dynamics, which we expect will serve as a near-term catalyst for the stock.
Flash pricing at retail level not as bad as market perception. We are raising our 3Q06 estimates for SanDisk following our
channel checks – including our retail and “e-tail” price checks – which point to slightly better than expected pricing (compared to
SanDisk’s guidance) for flash cards and USB drives in the quarter. Pricing in the spot and contract markets have been declining
through most of 3Q06, which has led to nervousness among investors regarding the ASP expectation for SanDisk. Spot pricing
for 4Gb and 8Gb NAND has declined by 18% and 44% so far this quarter respectively, while contract prices have declined by
23% and 24% for 4Gb and 8Gb respectively. However, looking at SanDisk’s retail prices on a sequential quarterly basis, our
analysis indicates that its ASP is tracking slightly better than guidance. Based on our analysis, assuming a decline of 13% MoM
in September across the board for SanDisk’s flash cards and USB drives, which is on the conservative side, we estimate SanDisk’s
overall ASP for 3Q should decline by 17% QoQ, which we believe is better than current market perceptions. We estimate that
retail prices would have to decline by about 20% MoM for SanDisk’s overall ASP to decline by the guided level of 19% QoQ,
which based on our checks is an aggressive price decline for September. A 10% decline in SanDisk’s retail pricing MoM for
September would result in a 16% ASP decline QoQ.
Raising 3Q EPS from $0.54 to $0.56, above consensus of $0.53. We are raising our 3Q revenue estimate from $705M (-2.0%
QoQ) to $720M (+0.2% QoQ), based on an increase in our ASP estimate from a 19% QoQ decline (which was in line with
guidance of a similar decline as 2Q) to a decline of 17% QoQ. We have assumed that SanDisk’s retail prices will decline by 13%
MoM in September. Based on our higher pricing assumption, we are also raising our product gross margin estimate for the
quarter, from 35.0% to 35.5%, above the guidance range of 33-35%. We are maintaining our bit growth estimate at 23% QoQ, in
line with guidance of 20-25%. Our EPS goes from $0.54 to $0.56, above consensus of $0.53. For 4Q06 and 2007, we are
maintaining our EPS estimates at $0.94 and $2.78 respectively, which remain above consensus of $0.75 and $2.74.
Street underestimating gross margin. The key reason for the delta between our 3Q and 4Q EPS estimates and consensus ($0.56
and $0.94 versus $0.53 and $0.75) we believe is our higher gross margin assumption. In light of the various cost drivers – 300mm
ramp, 70nm transition, lower non-captive supply – we believe SanDisk’s 3Q margin guidance was conservative, and that the street
is also underestimating SanDisk’s gross margin potential for 3Q as well as 4Q. Recall that the largest driver of gross margin
upside in 2Q (32.8% versus guidance of 28-30%) was recognition of more low cost Fab 3 production in cost of sales. We believe
the sweet spot for costs and margins has yet to come in 2H06, as the company has been rapidly converting its 300mm capacity
from 90nm to 70nm in 2Q and 3Q, and there is a lag of 1-2 quarters from the time of production to the time that production is
reflected in cost of sales.
Back-end loaded quarter, demand drivers in place for undersupply in 4Q. We would also remind investors that the third
quarter is a highly back-end loaded quarter, and that the seasonal peak for flash demand is still ahead of us in the fourth quarter.
Samsung recently indicated to us that the peak for flash demand for them is October and November. Demand from MP3 players
is expected to be a key driver of demand growth in the next three months. As we indicated recently, some investors have
expressed concern that the MP3 player makers may have already procured a significant portion of their flash needs for holiday
season demand, and thus the MP3 player market will not drive demand improvement for NAND in coming months. However, our
checks indicate otherwise – demand from the MP3 player makers should improve significantly in the next three months, and they
are expected to continue purchasing NAND for their holiday demand through November. In addition to the MP3 player market,
our checks indicate that demand from cell phones has been picking up rapidly in recent weeks, particularly due to the growth of
memory hungry MP3 phones, and we expect SanDisk to have a strong 4Q for handset cards. Overall, we continue to expect an
undersupplied NAND market in 4Q06.
Expect SNDK to continue to outperform in the near-term. SanDisk stock has clearly outperformed the market in recent weeks
(up 50% from the trough in July). Despite this move, we are reiterating our Outperform rating and $68 price target. We believe
the stock has yet to fully price in the gross margin upside and earnings potential for 2H06. Moreover, we believe we are at a
turning point for flash supply-demand dynamics, which we expect will serve as a near-term catalyst for the stock. |
