After Annus Horribilis, Chip Stock Prospects Are Bright

Wall Street year-end summaries take place in December, but for us, the switch to a new Hebrew year, around September, is always a good opportunity for reflection.

It was not a year that SanDisk Corporation (Nasdaq: SNDK) founder and CEO Eli Harari will soon forget, since in my opinion the firm was in real existential danger over the course of it. Like much of the market, SanDisk shares had a dramatic bungee jump, falling from $20 per share to a low of around $5 per share in November, and returning to $23 per share on the eve of Rosh Hashana.

September, about which there was concern it would be a black month for markets, was very green for SanDisk, whose shares are up 30% this month.

The turnaround in SanDisk's business over the past half year can be seen in reports by Bank of America Securities-Merrill Lynch analyst Simon Dong-Je Woo, who began to cover the company in March, with an initial "Sell" rating and target price of $6, which slowly crawled up to $10, as the share price rose to $20. He forecast then heavy losses in 2009 and 2010 for SanDisk, and only slight recovery in 2011.

Woo figured that SanDisk's partnership with Toshiba (TOSBF.PK) would burden it financially, and because of production costs which were higher than market prices, he also saw it at a disadvantage against competitors. Woo saw a difficult market ahead, where prices would collapse due to a chip surplus until at least the end of 2010.

Additionally, he suspected that Samsung (SSNLF.PK) would not renew its royalty agreement in which only one month later, in April, he was proven wrong, as Samsung and SanDisk did sign.

On Friday, he turned around, and switched to a "Buy" recommendation from "Sell", and tripled his target price to $30, much higher than the most optimistic analysts who covered the company, such as Lazard's Daniel Amir.

Today, Woo sees the mirror image of what he saw in March. Instead of chip surpluses, he sees a shortage, because of a sharp cut in investment. Instead of a disadvantage in its joint venture with Toshiba, he sees a very big advantage in production line ownership.

A wave is beginning, in his opinion, of positive trends in the NAND market, one which will last at least two years. From the demand side, it originates in higher usage of mobile storage in telephones and media players, led by Apple (AAPL). In the case that SanDisk will need more chips than it produces by itself, it will be able to buy them from Samsung, which in its new royalties agreement committed to sell to it at low prices.

Despite the sharp rise, I continue to recommend SanDisk and Apple for this year because I assume that they have unique advantages which will support them even if the exit out of the recession is slower than what the optimists among the experts estimate.

Among the shares I hold in my portfolio tracked by "Globes", I would add to the recommended list three more chip companies which have demonstrated a lot of power in the difficult year we've had. Marvell Technology Group (Nasdaq: MRVL), which rose 75%, Broadcom (Nasdaq: BRCM), which rose 64%, and Mellanox Technologies Ltd. (Nasdaq: MLNX), which rose 62%.

Each one of those three is well positioned in niches that will grow in the coming year: Marvell, due to its entrance into China's phone market; Broadcom mainly with a first significant entrance into the phone processor market through Samsung and Nokia; and Mellanox, with solutions for fast communication in large data centers through OEM giants like HP (HPQ) and IBM (IBM). HP and IBM began in the past year to compete with Cisco (CSCO), through, among other ways, Mellanox's solutions.

Comments

[Wisdom vs. ...:]

MLNX has strong competition from BRCD, ELX and QLOGC, i am wondering if they have a niche, or just a niche in niche

Sep 23 10:59 AM

[Dan Opp:]

It's doesn't seem prudent to me to cite an analyst who had it all wrong just 6 months ago. Obviously, SanDisk is extremely vulnerable to NAND pricing, as evidenced by their negative gross margins from 3Q08 to 1Q09. Conversely, as prices rise, so will SanDisk's profitability. These are givens. The difficulty lies in predicting future NAND prices. For now, supply is tight. But, if demand for mobile devices continues to accelerate and SSDs begin to gain significant share of the PC market, suppliers will ramp up again and prices will drop. Determining when this will occur in the future is akin to playing the lottery.

Long SNDK

Sep 23 06:26 PM

[Wisdom vs. ...:]

just read another article and will add: MLNX started delivering their 40Gb boxes this week; nehalum requires 40Gb (according to MLNX), interesting to see how nehalum sells and how quickly MLNXs competitors bring out their 40Gb boxes. still long ELX, but i am def open-minded.

'good news for a slow day' is spam thumb it down when you see it

Sep 23 11:51 PM