Should SanDisk Shareholders Be Worried About This Trend?

SanDisk (Nasdaq: SNDK  ) , the king of everything flash memory, attempted to yet again dazzle the market with earnings after the bell on Thursday -- only this time, the stock didn't pop as it has in the past.

The maker of NAND flash memory -- a type of fast access memory that's great for mobile data storage -- is seeing booming end markets as not only smartphones gain continuing adoption, but other areas such as tablets gain traction as well. However, despite flash-memory tailwinds from sources such as Apple's (Nasdaq: AAPL  ) bullish results -- and it's worth noting that Apple has been known to use Samsung and Toshiba predominantly -- and a 19% year-over-year jump in revenue, one key metric catches my eye as a threat to SanDisk's continuing rally: margins!

GAAP Figures

Q1 2011

Q4 2010

Q3 2010

Gross product profit margin

38.60%

39.50%

47.70%

Operating margin

27.00%

26.90%

35.00%

Source: Company filings.

SanDisk's margins have taken a nosedive in the most recent quarters as competitive pricing pressure, higher input costs, and increased research-and-development expenses have eaten into its bottom line. As you can see, in just two quarters, SanDisk has shed 800 basis points of operating margin -- yet its stock has responded by moving 32% higher over the past six months. Feel free to explain that, but don't hurt yourself trying.

What shareholders have to realize is that when you purchase a company like SanDisk, you're buying into a commoditized space. Although you can't physically trade flash-memory futures or anything of the sort, an oversupply or undersupply of flash products can significantly move flash-memory prices -- which, in turn, can drastically alter SanDisk's bottom-line results. In essence, SanDisk's earnings capacity is really capped by consumers' willingness to spend, and unfortunately, that willingness to spend is not going up as fast as the cost of fuel at the moment.

Even my personal darling in the memory-chip sector, Integrated Silicon Solution (Nasdaq: ISSI  ) , can muster only a forward P/E of 6.5, thanks in part to the entire sector's inability to control the pricing of its product. Exterior forces (i.e., consumers) control how these products are priced, and that situation makes outlooks very difficult to predict and margins very erratic.

Based on what I saw from SanDisk last week, I'd say it's nearing rarefied territory, trading at a double-digit multiple for a stock with plummeting margins. In its defense, the company is ripe with cash and did generate $121 million in free cash flow during the quarter, and its cash flow from operations soared relative to a year ago. Still, with margins falling as dramatically as they've been, I'd have to think the company is going to have to deliver for shareholders pretty soon. Otherwise, we may have seen yet another peak in the flash-memory cycle.

What’s your take? Does SanDisk still have its flash, or will higher margins soon become a distant memory? Consider tracking Sean's prediction by adding SanDisk and your own personalized portfolio of stocks to My Watchlist.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He would like to remind you not to forget about our friends in Japan who could still use a helping hand. You can follow him on CAPS under the screen name TMFUltraLong. Apple is a Motley Fool Stock Advisor selection. Motley Fool Options has recommended that members create a bull call spread position in Apple. The Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never flashy but always in style.


Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 22, 2011, at 10:34 PM, millsbob wrote:

    really reaching, dude.

    a lot of companies would kill for those margins.

    really, Really reaching.

  • Report this Comment On April 23, 2011, at 12:25 PM, stocktrader2000 wrote:

    You need to go back and reread the earnings call and related financial notes. First of all product gross profit was $473.7mm against product revenues of $1210.2mm. Thus the gross profit margin was 39.1%. However, Sandisk took a one-time charge $25mm for a power outage in Fab 4 and the Japan earthquake. If you back out that charge the actual product gross margin was 41%. Down from Q3 2010 but higher than Q4 2010.

    More importantly, the Company actually raised it's margins guidance for the year. Product margins were raised to 37-40% from a previous range of 35-38%. Gross margins were raised to 41-44% from 39-42%.

    Yes it's a commmodity business and yes margins will rise and fall depending on demand but the overall growth story is undeniable given the growth in end user devices and applications.

    If you are going to write a story based on your views please at least get the facts straight.

  • Report this Comment On April 23, 2011, at 3:48 PM, stocktrader2011 wrote:

    Aside from stocktrader2000's excellent comments, Sandisk's lower margins of the past couple of quarters were also affected by the stronger yen, a factor which will likely reverse over the coming year. Plus they are in the process of qualifying their x3 chips for use in more embedded applications. This is a big deal because they are the only NAND vendor that is able to produce x3 that is equivalent to MLC chips, even though x3 chips are about 20-25% cheaper than MLC. Those qualifications should be complete by the time the holiday season begins in late summer, and will be another factor that will expand margins back to where they were in Q3 and Q4 of last year. Their success in getting more of their chips embedded in smartphones and tables was actually another reason why their margins contracted slightly in the most recent quarter, since they used relatively more MLC than x3 in Q1 than Q4. But when the x3 qualifications are complete, that factor will be reversed.

    Sandisk's story is still intact.

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