SanDisk - Sell-Off Is Warranted After Very Strong Momentum And Worries About Sales And Margins

Jul.18.14 | About: Western Digital (WDC)


SanDisk reports second quarter earnings which are in line with expectations.

Analysts are worried about a weak third quarter sales outlook as SanDisk aims to avoid oversupply which could pressure margins.

Despite the soft sales outlook, margins are also seen under continued pressure.

As such the 15% sell-off can be justified, especially as shares are still up by a third this year.

SanDisk (SNDK) reported inline results for the second quarter, yet a disappointing outlook for the remainder of the year triggered a fierce sell-off in a general weak market.

Shares of the company had seen incredible momentum in recent months in anticipation of the earnings release. This has pushed up expectations for the earnings report too much, and SanDisk's outlook was too disappointing to avoid a fierce sell-off.

Highlights For The Second Quarter

SanDisk reported second quarter revenues of $1.63 billion which represents 11% growth on an annual basis, while revenues are up 8% from the seasonably weaker first quarter. The topline results were slightly better than analysts have been anticipating, with consensus estimates standing at $1.60 billion.

GAAP earnings came in at $274 million, up merely $5 million from last year. Thanks to sizable share repurchases, earnings per share growth was much more impressive. Reported earnings of $1.14 per share rose by eight cents.

On a non-GAAP accounting method earnings rose to $1.41 per share which was two pennies above consensus estimates.

Key Trends During The Quarter

CEO Sanjay Mehrotra was happy with the results especially with the performance of SSDs. These sales now make up 29% of total sales compared to 16% last year.

While reported topline sales growth was still solid, SanDisk did experience some margin pressure. Actually the firm managed to boost gross margins by about 70 basis points to 46.5% of sales, while notably operating expenses crept up.

Operating income was down by 110 basis points to 25.5% of sales as operating costs rose sharply. The increase in costs was seen amidst all cost categories, with R&D, sales and marketing as well as general and administrative expense growth all outpacing reported revenue growth.


SanDisk has a very strong financial position. On top of the nearly $2.7 billion in cash and short term investments, it holds another $3.6 billion in long term marketable securities. Subtracting the $2.2 billion in convertible debt outstanding, still yields in a comfortable $4 billion net cash position.

On a trailing basis, SanDisk has now reported revenues of $6.5 billion on which it net earned about $1.15 billion.

Factoring in the big losses following the earnings release, shares are valued at around $21 billion currently. This values operating assets at roughly $17 billion, after subtracting the net cash position held by the business. As such equity is valued at 2.6 times sales and 14-15 times trailing earnings.

Strong Performance, But What Does The Future Hold?

Over the past decade, SanDisk has aggressively and profitably expanded its operations. Revenues have grown at a compounded annual growth rate of close to 15% per year, boosting revenues from $1.8 billion in 2004 towards $6.5 billion on a trailing basis.

With exception of a big loss in 2008 driven by one-time issues, earnings have grown rapidly as well, surpassing the billion mark in the meantime. At the same time, the total dilution of about 20% was limited over the time frame, resulting in rapid growth on a per-share basis.

Yet it is very hard to achieve these results going forwards driven by pricing pressure and the increased size of the firm. For the third quarter, things are not looking so good. Sales for the quarter are seen between $1.68 and $1.73 billion, suggesting year-on-year growth is slowing down to 5% at the midpoint of the range. Analysts were looking for sales of $1.74 billion.

It appears that the company has deliberately held back on production to avoid oversupply which could crush margins. In the conference call management admitted that demand is not the issue, the weaker third quarter guidance stems from not having enough inventory to meet demand.

Not only is the sales guidance a bit soft, analysts are worried about margin pressure as well. This most likely results from SanDisk supplying to Apple (NASDAQ:AAPL), which given its superior position can likely demand favorable prices. As such average selling prices are declining quicker than costs, putting pressure on gross margins.

Takeaway For (Potential) Investors

Back in June of this year, I last checked out the prospects for investors in SanDisk following the acquisition of Fusion-Io, which gave the company a stronger position in the SSD market.

I liked the strategic nature of the deal and the "timing" of the acquisition with SanDisk acquiring shares at a 70% discount from Fusion-Io's all-time highs. The $1.1 billion deal allows SanDisk to gain a greater foothold in the SSD market which the company expects to grow from $5 billion in 2013 to about $8 billion by 2015.

Shares started the year around $70 and have simply seen too much momentum. Since the middle of April shares have risen from $75 to highs of $109, for returns exceeding 40% without seeing any meaningful correction until now.

While a double-digit correction to $95 per share seems very dramatic, I certainly believe that this correction should be seen in consideration with the huge gains being made over the past few months. This is as expectations have simply risen too much, too quickly.

While the risk-reward position has improved following the news, shares still trade at elevated levels, and I don't necessarily believe that current levels are a great entry opportunity.

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