Tuesday, February 20, 2007

Color on news: Sandisk (NASDAQ:SNDK)

Several firms out with cautious comments on Sandisk (NASDAQ:SNDK) after the co issued weak guidance and news of restructuring. At least one firm is downgrading the stock.

- Citi notes SNDK reset its bar (aligning directionally with pricing they've noted) for 30-40% 1Q price cuts and an ugly 2Q. Gross margins severely pressured thru 3Q07 with only partial EPS offset from 10% staff cut ($0.10 per anum).

Why now? Citi's initial take = clear decks pre-2/26 analyst day to clarify messaging, though in reality an urgent need to get cost cuts implemented.

Could things get worse? Unfortunately, yes. 1Q07's worse-than-feared retail pricing (by 500-750 bps), and 2007's gross margin meltdown (~500 bps worse than thought) should cut Street EPS by 45% for 2007E and by 20% for 2008E. Further as fab III and fab IV cap ex plans are maintained, end-demand must solve oversupply problems, lending little confidence to 2Q07 and 3Q07 gross margin modeling and therefore conviction that SNDK shares may find a bottom today.

The firm is reducing 2007E/2008E to $1.04/$2.04 from $1.33/$2.10. Street ests, overly aggressive post-4Q06 results (43% and 20% above their prior '07/ '08 ests), if reset to more realistic levels, could help the stock find a bottom in 1H07. Maintains Hold and $44 tgt.

- Merrill Lynch notes SanDisk's announcement underpins their belief that there are few near term demand drivers that could soak up the industry oversupply. Combined that with limited manufacturing leverage for SanDisk prior to Fab 4 ramp and the ongoing integration with the former m-systems business, they believe SanDisk's margin will stay at a low level in the next few quarters. That being said, they think aggressive pricing will stimulate new demand sooner than the street expects, and they have written about the solid state drive (SSD) opportunity a few weeks ago.

Firm's GAAP earnings estimate for 2007 goes from $0.88 to $0.30, which includes the impact of restructuring charges. On an adjusted basis, estimate goes from $1.80 to $1.25. We assume 160% bit growth and 60% price decline in 2007.

The cautious tone was very similar to two weeks ago when management provided its business outlook during the earnings call. Until visibility on pricing improves, the firm recommends investors to stay on the sideline. Rating remains Neutral.

- ThinkEquity's Eric Ross looks like the most optimitic of the bunch saying that with the NAND flash market seeing significant ASP erosion in 1H07, SanDisk announced Friday a series of cost-cutting measures designed to help counter falling NAND flash prices. The company's announced cost-cutting programs should help offset some of the weakness in memory prices-the first in recent memory. Any upside to SNDK shares may be limited in the near term even though the firm believes sentiment may be reaching its bottom. They are lowering their estimates and price target from $47 to $45, but reiterate Accumulate rating.

Lower ASPs should not be a surprise. Two weeks ago, Micron said during its analyst meeting that ASPs are falling 30-40% Q/Q in NAND. Hynix had already said this as well. Now SNDK is saying this-this should not be new news. In fact, MU's comments were what prompted the firm to lower their price target to $47, and now they slightly lower it again.

The NAND market is further weakened by the fact that there are no new applications to help spur demand in the consumer electronics market that will help absorb the added capacity that is coming online and to materially tip NAND flash market demand in thenear term. Cell phones have not taken up the slack as soon as we expected, and the iPhone has not been the driver many in the channel were led to believe. However, management believes that the NAND market should pick up in the second half of this year. In our opinion, demand from mobile phones and new products such as the hybrid drives are possible long-term demand drivers.

- Baird is downgrading SanDisk to Neutral from Outperform and reducing price target to $43 from $55 on the basis of a reduced gross margin forecast. SanDisk announced cost cutting measures and said gross margin pressures (without quantifying) would likely continue in a press release last Friday. Stock fully valued on the basis of firm's new 2008 forecast (new 2008 GAAP and pro forma EPS estimates are $1.48 and $2.00, down from $1.73 and $2.25, respectively). Licensing term renegotiations in 2008 provide a murky profitability picture longer term.

Notablecalls: SNDK traded down 4-5% in after market action late Friday. I suspect the stock will open down no more than say 5-6%. While I have no feel for short term price action I think SNDK will keep going down over the next couple of months. How much would you pay for $1.80-$2.00 EPS power in 2008? 20x? Probably less, something more closer to 16x (SNDK's EPS power for 2007 is around $1.00-$1.50). No reason to own this one around current levels. Please see archives for further color.

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