SanDisk: I Remain Bullish

Oct. 4.13 | About: Western Digital (WDC)

SanDisk Corporation (SNDK), the maker of electronic data storage equipment, is trading near its 52-week high. The company has a market capitalization of roughly $15 billion and is up about 42% year-to-date. The last time that I wrote about SanDisk, I said the range to get bullish on shares is the $47-$57 range. The share price dipped below $55 and is now trading at $61.54. So, assuming that $57 was the purchase price, the investor would be up about 8% in just under a quarter. Moving on, SanDisk recently reported fiscal second quarter earnings.

SanDisk reported excellent second quarter earnings on strong top-line growth. The company also re-paid debt during the period. Relative to my forecast, SanDisk reported slightly better than expected revenue, and the operating margin was higher than my conservative estimate. Consequently, I'm going to increase my forecast for this fiscal year.

I think 2013 revenue should be in the $5.8 billion to $6.2 billion range with operating income in the $1.3 billion to $1.6 billion range and net income in the $600 million to $900 million range.

I remain bullish on the common equity shares of SanDisk. The stop loss level is now the $57 per share level. In this report, I'm going to analyze a peer group's asset utilization, financial performance and valuations.

Asset Utilization

Asset utilization metrics measure a company's operating efficiency. I'm going to measure the operating efficiency of Micron (NASDAQ:MU), Western Digital (NASDAQ:WDC), Seagate (STX) and SanDisk. All four of the firms are roughly the same size, and they compete in the data storage industry. I'll examine the company's operating efficiency separately and compare the company's operating efficiency.

SanDisk is becoming less efficient by almost every metric, but its inventory management has improved. Western Digital is also becoming more inefficient. Seagate was heading toward becoming more inefficient but was able to increase efficiency in 2012. Micron was able to increase efficiency, overall, but the company has become less efficient recently.

Overall, Seagate is the most efficient company followed by Western Digital Corporation. Micron is third and SanDisk is the least efficient company. In terms of customer credit, SanDisk has the highest receivables turnover, which could mean that SanDisk has the most strict credit policy. I believe that Seagate and Western Digital have less strict credit policies, based on knowledge of the customers of the companies.

Seagate may not be carrying enough inventory and could benefit from loosening the credit terms offered to customers. Micron and SanDisk probably have slower moving inventory. Western Digital is efficiently managing its inventory. Western and Seagate are more efficient in terms of assets.

Overall, Western Digital is the best performing in terms of asset utilization, but Micron and Seagate are the companies showing improvement. SanDisk, the focus company, could improve its asset utilization as it continues to expand rapidly. I would be bullish on SanDisk, Micron and Western Digital based on this analysis.

Financial Performance Analysis

In this section, I'm going to analyze the historic financial performance of Micron, Seagate, Western Digital and SanDisk. I'll examine the relative profitabilities, growth rates and productive capacity relative to revenue. At the end, I will reach a conclusion based on the data.

In terms of size, Western Digital and Seagate are the largest by revenue, and SanDisk is the smallest by revenue. But, SanDisk is the most profitable and Micron is the least profitable. The companies sell different products, but for investment purposes, I would favor SanDisk's profitability. Micron's ability to generate operating profit is inconsistent. Western Digital and Seagate are also investment candidates based on profitability.

I'm going to use the 10-year revenue and EPS growth rates to compare the companies. SanDisk and Western Digital are the fastest growing companies. Seagate is growing in the high-single, low-teens range. It is worth noting that SanDisk's growth rate is slowing, but the growth rate remains bullish for the valuations.

SanDisk has the least productive capacity, and Micron has the most productive capacity. Relative to revenue, SanDisk and Seagate are generating a substantial amount of revenue relative to productive capacity. Micron needs to do a much better job of generating revenue from its resources. SanDisk has done an excellent job of generating revenue without over investing in production equipment.

The historic profitability, growth rate and productive capacity to revenue generation are bullish for the valuations of SanDisk.

Valuations

I'm going to use a few models to value the common equity shares of SanDisk. One model estimates what the market is paying for the growth of the firm, and the second model is the multiplier model. SanDisk is growing in the 20+% range.

Now, we'll discuss how the market is pricing the growth opportunities of the firms. The market is pricing the most growth into the share price of SanDisk. Western Digital and Seagate have roughly equal amounts of growth priced into their share prices, but Western Digital does have slightly more growth priced into its share price. Investors are demanding more compensation for holding shares of Seagate. Said differently, equity is expensive for Seagate. The cost of equity capital is roughly the same for SanDisk and Western Digital. Overall, I would say that those are fair assessments, but I would require a slightly higher required return for holding shares of SanDisk relative to Western because of the size difference. The SanDisk justified PE using this metric is 16.96. SanDisk has a forward PE of 11.7.

SanDisk Seagate Western Digital
2.7 1.2 1.0
21.0 9.5 16.2
Click to enlarge

The market is paying the highest premium for the sales and earnings of SanDisk, because SanDisk has the highest growth rate. Seagate has the lowest growth rate and deserves the lowest multiples. Western should be trading at a higher sales and price multiple. Given the growth forecast, shares of SanDisk are pretty reasonably priced in the market.

The valuations don't suggest that shares of SanDisk are overvalued.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.