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Is SanDisk (SNDK) Stock A Flashy Investment?
Posted by: Magic Diligence (IP Logged)
Date: December 27, 2013 09:39AM

If there is one trend in electronics over the past 10-15 years that towers above all other, it is mobility. Starting with PDAs in the late 1990's, the portability trend has expanded through a huge number of categories, starting with MP3 players like the iPod and continuing into GPS devices, smartphones, tablets, electronic book readers, ultra-thin and low power notebooks, wearable fitness trackers, etc. In fact, I'm willing to wager that you or someone in your family received some kind of portable electronic device as a holiday gift this year. Mobile electronic devices have become ubiquitous in our world.

One of the core technologies that make this possible is flash memory storage. Flash has many advantages over traditional mechanical hard drive storage. Flash is more durable (minor drops and bumps usually won't damage it), requires less power (important for battery operated devices), can be manufactured in much smaller and unique form factors (important for slim/light devices), and have faster read access times (making the device feel faster).

With these advantages, along with falling prices and the continuing move to mobile, a pure play flash stock selling at a price cheap enough to be screened by Magic Formula® Investing should be an interesting investment candidate.

SanDisk (SNDK) - A Pure Play on Flash

SanDisk is one of the only pure plays on flash in the market. SanDisk breaks its sales into two channels. The Retail channel is flash storage cards/sticks for smartphones, digital cameras, and the like (about 37% of sales). The Commercial channel includes embedded flash solutions for OEM customers and solid state drives, or SSDs, that replace traditional hard drives in newer PCs. SanDisk has moved aggressively into Enterprise SSDs with the purchase of SMART Storage Systems a few months ago. SSDs now represent about 20% of revenues, from just 10% a year ago.

Revenue growth is a highlight of an investment in SNDK. The company has grown the top line at a compound annual rate of 13% over the past 5 years, and over 20% over the last several quarters. Bit supply growth in 2013 has been about 20%, and is expected to be about 30% next year. Make no mistake, the move to flash storage will continue to be a secular trend in electronics.

Another thing I like is SanDisk's move towards embedded flash and SSD solutions instead of relying on retail card sales. Cards are off-the-shelf items that consumers often purchase based on price instead of brand. Embedded solutions are designed in to products and often have at least 1 year of sales, in addition to establishing OEM relationships that lead to repeat business. They are also less price sensitive - it is remarkable that SanDisk has recently been able to increase price-per-gigabyte (by 12%) while continuing its historical ability to reduce cost-per-gigabyte (by 19%). These factors should both improve the base gross margins for the company while easing some of its historical volatility. Speaking of which...

Flash - A Commodity with Volatile Supply/Demand Dynamics

Flash memory is a commodity. SanDisk has a lot of big, established competition, including Hynix, Intel (INTC), Micron (MU), Samsung, Toshiba, and other smaller, generic producers. There is nothing special or rare about it - the only limit to supply are what semiconductor fabs can produce.

Given this fact, and the fact that consumer electronics (CE) is a cyclical industry, flash supply and demand balance is very tenuous. Frantic production to catch up to demand often leads to dramatic over-supply when the CE market cools off. One needs only to look at SanDisk's financials to see this. The company swung from a $917 dollar operations loss in 2008 to a $1.5 billion dollar profit in 2011, and which was then cut in half to just a $700 million profit the following year!

SanDisk right now is in a good supply/demand market. Sales are growing at 25%, and gross margins are at the high end of the company's 30-50% range. But we always need to plan for the next pothole in the road, which history shows us is not too far in the future.

Is SanDisk A Buy?

SanDisk should continue growing revenues, and the transition into embedded and SSDs is favorable. Additionally, the company just recently started paying a dividend (a skimpy 1.3% yield), and aggressively buying back shares ($1 billion in Q3 alone). The EBIT/EV earnings yield of 11.3% and cash yield of over 10% both look really attractive for this kind of growth. So is SanDisk a buy?

MagicDiligence's answer is a solid "maybe". Forecasting about 140% growth in free cash flow for 2013, followed by 10-15% growth from there, with an inevitable 50% pothole like 2012 along the way, I see SanDisk worth about $79 per share. That's about 13% of upside to the current price. While I'm slapping the "positive" opinion on the stock, 13% is not enough margin-of-safety to recommend it, especially in such a volatile industry.

It is a reasonable opinion that SanDisk's business changes could soften bumps in the road going forward, and an argument could be made for a more aggressive growth assumption. SanDisk is a difficult stock to lock down a price for, and there are a wide range of potential outcomes here.



Stocks Discussed: SNDK,
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