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Flash: SanDisk shares take a beating
Flash-memory company's stock is paying the price for inflated expectations in the face of a tough pricing environment and the prospects of increased competition.
By Robert Walberg
The current earnings season has not been kind to the markets hottest stocks.
First Yahoo!, then Apple Computer, and now SanDisk have taken big hits in response to quarterly profit reports.
That's despite the fact that, like the others, SanDisk (SNDK, news, msgs) reported exceptionally strong results.
Bolstered by demand for the companys flash memory cards, earnings for the fourth quarter of 2005 were up 62% from a year ago, driven by a 37% jump in revenues. Whats more, sales and earnings were comfortably above the consensus estimates. Unfortunately, great expectations can result in great frustrations, and nowhere is this more evident than on Wall Street.
Investors will certainly be frustrated when they see that the stock tumbled more than 12% in after-hours trading. Why did SanDisk take such a beating? Running too far, too fast is one reason. Inflated expectations are another. But unlike with Yahoo! (YHOO, news, msgs) and to a lesser extent Apple (AAPL, news, msgs), SanDisk faces some real threats to growth targets.
Supply-demand problems
First and foremost, the company faces serious pricing issues due to a growing supply of flash memory. In its post-earnings press conference, management noted that it had initiated price cuts of 25% to 30% in Europe and the Pacific Rim, with similar discounts slated for early February in the Americas. The Street was expecting price cuts of only 20%, according to Avian, a Boston-based information technology research firm that correctly advised clients to short SanDisk about 20 minutes prior to yesterdays close.
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For the year, SanDisk indicated that average selling prices will decrease 50% to 55%. That might sound awful, but its consistent with about a 52% decline in the NAND spot flash market last year. NAND is one of the flash technologies used in memory cards, providing storage for MP3 players, digital cameras and USB drives.
In light of the pricing pressure, it wasnt surprising to hear SanDisk guide first-quarter gross margins down to 30% to 32%, from 34.4% in the fourth quarter. Dont be shocked if analysts trim their earnings estimates in the days ahead. Nothing trips up a stock like sell-side downgrades.
There are also some questions concerning flash demand. The boom in digital cameras over the past few years is finally beginning to slow and, as such, its natural to assume that the rate of growth in the flash memory market will also slow. The pace of decline doesnt need to be huge for it to have a serious ripple effect on the flash industry, given that expectations and valuations are high. Even a marginal sales slowdown could trigger a snowball effect with regard to pricing.
SanDisk also faces increased competition. It wasnt that long ago that the stock took a dive into the mid-$40s on news that Intel (INTC, news, msgs) and Micron Technology (MU, news, msgs) were forming a new joint venture known as IM Flash Technologies. Though the new venture isnt likely to gain much traction until 2007, it merely adds to concerns over excess capacity.
Ready to buy if things get worse
So it was surprising that SanDisk experienced such a dramatic advance over the past couple of months. The stock surged 75% from its December 2005 low to a high of $79.80 in early January. The gains were driven by analysts who pointed to the possibility of increased demand for high-end flash from customers such as Apple and Sony, and growing market share in the MP3 market. Some said the stock could hit $100.
Those of you that follow my column know that I used the buying frenzy to unload SanDisk and M Systems Flash Disk Pioneers (FLSH, news, msgs) from my Street Patrol portfolio a couple weeks ago. That decision looks good right now. If the selling gets as overdone as the buying, however, growth-oriented investors will want to consider jumping back aboard SanDisk.
As it stands right now, with the stock hovering around $63, SanDisk trades at about 26 times estimated fiscal-2006 earnings of $2.39 share. Considering that the company is still looking at sales and earnings growth north of 20% this year, thats not a bad multiple. It's not yet enough to compensate for the growing number of questions facing the company and the industry over the coming year, but it's getting much closer.
I would be much more excited about the stocks prospects as an investment if it retested support in the $55 to $54 area. I just might get lucky enough to add some more at that price within the next few months.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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