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Is SanDisk a Healthy Investment after Earnings?

July 18, 2014 | About:
Riddhi Kharkia

Riddhi Kharkia

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Quite recently, SanDisk had been trading at all-time highs on the back of strong partnerships with giants like Apple (AAPL) and Western Digital but the stock price has stumbled over the past few days owing to concerns around its earnings call. The share price saw a fall of approximately 14% after its profit margins and sales forecasts fell short of some analyst estimates. Now, after the company reported actual results for the second quarter along with the guidance on third quarter, the stock dropped around 9.8% in after-hours trading.

A condensed view of the earnings

SanDisk Corp reported second-quarter 2014 adjusted earnings of $1.31 per share, in alignment with analyst estimates. Additionally, earnings per share increased 13.4% from the year-ago quarter. Total revenue increased 10.7% on a year-over-year basis to $1.634 billion, beating the top-end of management's guided range of $1.550 billion-$1.625 billion.

Further, SanDisk's adjusted gross profit (including stock-based compensation but excluding other one-time items) for the quarter came in at $779.4 million, up 13.5% form the year-ago quarter. Adjusted gross margin also increased 119 basis points (bps) on a year-over-year basis to 47.7% primarily due to a high-growth in revenue. However, the operating margin for the company declined by 58 basis points mainly because of an increase in the operating expenses. As per data from the earnings call, SanDisk made comparatively higher disbursements towards research and development expenses, sales and marketing expenses and general and administrative expenses in the said quarter.

One reasonably happy highlight of the earnings call was an increase of 14% y-o-y in the revenue from commercial channels which forms around two-thirds of SanDisk’s overall revenue. Besides, the growth in SSD solutions was nothing short of phenomenal as the company reported a jump of 97% y-o-y for this category.

Why did the share price fall then?

In spite of quite an upbeat second quarter results, the stock was at the receiving end of investor scepticism. One of the main reasons behind SanDisk’s significant fall was the lacklustre guidance provided by the company for Q3. Before entering into a discussion on the third quarter guidance, take a look at the guidance given by the company. SanDisk expects revenues for the third quarter to be between $1.675 billion-$1.725 billion compared with analyst target of $1.74 billion. Also, it expects the third quarter non-GAAP gross margin to be in the range 47.0%-49.0%. SanDisk expects operating expenses in the range of $320.0 million to $330.0 million. The company expects non-GAAP tax rate to be 31.5% in the third quarter.

A tepid guidance on revenue growth and margins was not received well by the investors in spite of favourable second quarter results. As a result, SanDisk slid reasonably in trading after the results were reported.

The partnership with Apple might not be that great

At the very onset, I mentioned about SanDisk’s partnership with Apple, an alliance that most chip-makers would enter into happily. However, the company’s relationship with Apple might be one of the reasons that the investors are seeing downbeat margins. As this article reports, SanDisk has a proportionately high inclusion of embedded products to be shipped to Apple in the second half of the fiscal on which the company achieves less than corporate average margin.

There is hardly any doubt that the investors of SanDisk would not be quite content on receiving such news mainly because of the pinned hopes around the launch of iPhone 6. If rumours are to be believed then Apple is poised to launch its power-packed smartphone somewhere in the month of September and as such, investors were hoping a boom in SanDisk’s business being one of its biggest suppliers. However, the low margins on custom products demanded by Apple has disappointed investors (evidenced by the fall on the exchange) and will be a strong indicator of company’s margins in future as well.

The silver linings

In one of the paragraphs above, I mentioned the healthy growth enjoyed by the company in SSD segment. It is anticipated that the trend would continue as SSDs are becoming a preferred data storage medium over mechanical hard-disk drives. Both client and enterprise SSD divisions are exhibiting robust performance and are on track to achieve record revenue in the quarter. The recent deal made by the company to acquire Fusion-io Inc (FIO), a provider of flash-based PCIe hardware and software solutions for $1.1 billion in cash will help SanDisk enhance its flash memory storage portfolio and build a better presence in Enterprise SSD markets.

Additionally the stabilization of PC demand as was also reported by IDC a while back will benefit SanDisk. Its broad portfolio of SATA and PCIe client SSD solutions will be useful in serving all leading PC OEMs well in the coming quarters.

Final opinion

While there are some big headwinds that will influence the price of SanDisk in coming days, it cannot be denied that there are some big opportunities as well. Trading at a huge discount to an all-time high of $107.83, the current price is definitely a bargain. Hence, it is an ideal time to invest in SanDisk and take leverage of the growth in SSDs and bettering PC demand.

About the author:

Riddhi Kharkia
A practicing Chartered Accountant based out of India. I have keen interest in analyzing tech stocks that are driven by value.

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