SanDisk May Be Undervalued

| About: Western Digital (WDC)

SanDisk Corp. (SNDK) reported solid fourth-quarter results with mid-single digit sequential revenue growth. This came on the back of strong solid-state drive sales and strong demand from the retail channel for memory products. Additionally, the profitability profile improved during the quarter.

Management is calling for high-single digit revenue growth during the first quarter with full-year revenues between $6.4 billion and $6.8 billion. SanDisk should benefit from a healthy supply/demand balance in the NAND flash memory space in the coming quarters. But management believes that ASPs will be slightly softer in calendar 2014 than the prior year.

Overall, the improvement of the profitability profile, the excess liquidity, and the valuation suggest SNDK still has a considerable amount of upside potential. In my opinion, SNDK should be valued at a premium, 3 times book, to the market.

Recent Developments

  1. SNDK declared a first quarter 2014 cash dividend of $0.225 per share on the company's common stock. The dividend will be payable on February 24, 2014 to stockholders of record at the close of business on February 3, 2014.
  2. The ULLtraDIMM SSD, the industry's first enterprise-class, ultra-low latency, memory channel storage solution, is now shipping for qualification with select enterprise servers. IBM will use the ULLtraDIMM under the eXFlash DIMM brand name, which given IBM's recent server sales is less than exciting news.
  3. SNDK announced an investment in Nexenta Systems, a leader in the fast-growing software defined storage market. Nexenta has over 5,000 customer deployments with more than 800 petabytes of storage under management; also, the company partners will Dell, Cisco, and others to support cloud deployments, which are built on CloudStack and OpenStack solutions.
  4. SNDK announced the 64GB SanDisk Connect Wireless Flash Drive.
  5. SanDisk and Avnet signed a global distribution agreement.
  6. Thomson Reuters named SNDK a Top 100 Global Innovator.

Business Summary

SanDisk Corporation is a global leader in flash storage solutions. SNDK sells chips to device makers of smartphones, cameras, and other mobile devices. Also, SNDK is increasingly using NAND chips in its own branded solid-state drives, which are sold directly to companies and consumers. While they remain significantly more expensive than mechanical hard drives, SSDs are gaining popularity in data centers and consumer laptops because of their increased efficiency.

The SSD product revenue performance was impressive and represented 19% of annual revenue. This came on the back of next generation mobile and enterprise data storage solutions. But management expects memory chip prices to fall more this year than in 2013. Additionally, as SSDs become a larger portion of the company, earnings should become less volatile.

During the fourth quarter revenues increased 12% relative to the year-ago quarter, which was accompanied by a cost structure that enabled margin expansion. The operating margin expanded from 22% to 29.4% of revenues. Diluted EPS increased 66.7% relative to the year-ago quarter and 22.9% sequentially.

The annual financial performance was also impressive with revenue increasing 22%, which was accompanied by margin expansion. Operating income more than doubled as the operating margin expanded from 13.8% to 25.3%. Diluted EPS increased 156%. The financial performance justifies price-based valuation multiple expansion.

At the end of the calendar year, the cash ratio was 2.36, and the current ratio was 3.78. There was excess liquidity, which can be used for share repurchases or dividends. The financial leverage ratio was 1.51, which was partly attributable to a substantial amount of long-term marketable securities. Management should either return capital to investors or use the capital for strategic acquisitions, because there was ~$6 billion of cash on the balance sheet.

Cash flow from operations increased from $530 million to an unsustainable $1.86 billion. There were $101 million of dividends paid during the year with $1.6 billion of share repurchases. So, in my opinion, the dividend will ramp at a rapid pace over the next few years. Capital expenditure was in the $200 million to $500 million range the past two years with free cash flow of $1.65 billion during this fiscal year.

Management expects revenues of $1.45 billion to $1.52 billion for the first quarter, and $6.4 billion to $6.8 billion for the full year. First quarter 2013 revenues were $1.34 billion with a GAAP gross margin of 40%. The guidance represents 8% revenue growth at the low end.


  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in SanDisk in light of their own unique circumstances.
  3. A decline the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for SanDisk's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in SanDisk.

Valuation Portfolio Management

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From a technicals perspective, it appears that SNDK is heading towards being in a trader's market. But the share price can keep going higher as the intermediate-term and primary-term trends are towards higher prices. That said, throwbacks to the 50-week or 200-day simple moving averages are dips to buy; more aggressive investors would use throwbacks to the 50-day SMA.

Relative to the S&P 500 (NYSEARCA:SPY), there isn't much of a diversification benefit from investing in SNDK. The correlation since 2009 is 0.90. That drops to 0.81 since 2011. And since 2013, the correlation is 0.95. There is a strong linear relationship between the share price of SNDK and the S&P 500.

Should we include forecasts for the broader market into our return expectations for SNDK? Since 2009, fluctuations in the share price of the S&P 500 explained 81% of the variations of the share price of SNDK. That number drops to 66% since 2011, and is 90% since 2013. So, forecasts for the share price of SNDK should include forecasts for the S&P 500.

I employ 3-month, 6-month, and 12-month price targets. The price targets are $64.05, $67.25, and $71.68, respectively. At $72 per share, SNDK is trading above trend, which suggests a period of underperformance is likely in the coming months.

Is SNDK likely to underperform the market in the coming months? Using my proprietary model, SNDK doesn't appear likely to underperform the market. I place the chance of outperformance at 60%. But the share price of both could decline with SNDK declining less than the broader market.

The fundamentals of the company suggest that it should be valued above the market multiple. But SNDK trades at 2.5 times book while the market trades at 2.6 times book. The valuation suggests that the share price has upside potential; conservatively, I would price SNDK at 3 times book.

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.