The Memory Industry Is Stabilizing and SanDisk Is Ripe

SNDK is a memory company that is in the midst of being re-rated as the industry enters a stable margin phase, due to better capex discipline from the players. While the stock has done well since the bottom, I feel it still offers a good value given its high cash balance (and greater willingness to buy back stock) and a stream of royalties.

The company is trading at 15x P/E on 2013E earnings, with earnings upside as NAND prices should stabilize in the 2H due to better supply/demand conditions. SNDK is best positioned in the industry as it has the highest revenue mix from SSDs (~20%), which are the fastest growing/highest margin segment. SSDs will replace HDDs fairly rapidly for consumer notebooks, while they also replace HDDs in servers/enterprise storage.

Continued growth of smartphones and tablets support the demand outlook for the next several years. Sandisk is best positioned in SSDs due to its advanced controller technology, which is becoming more important in NAND. Players like Hynix are less able to take share in this market, and since Hynix is the marginal player here I think pricing pressure for SSDs will be less than for the overall market.

Supply is likely to be capped as a tech change into 3D NAND in a few years means there is great technological uncertainty, and players are unwilling to invest large amounts of capex in old technology. The market is fairly well disciplined with only 4 camps (Toshiba/SNDK, Samsung, Micron and Hynix), and Toshiba/SNDK together control over 50% of the market.

While consensus has only +9.7% revenue growth next year, I believe revenue can grow mid-teens, with supply growing about +30% and price declining -10-20%. Margins could move up to 46% range vs. consensus 44.5%.

Valuation: The company trades at 15x earnings, but we have to take into account net/cash share of about $5bn (30% of market cap!), which would bring the P/E of the biz to only 10x, for mid-teens sustainable growth. Furthermore, company has a royalty stream of ~$400m/year which should grow at about 5-10%/year, accounting for about ~20% of 2014 earnings, which deserves a higher multiple of around 20x given the stability of this cash stream. On a EV/FCF basis, it is only trading at 10x FCF for 2013 (not a peak gross margin year). As the memory industry stabilizes, I believe valuation can re-rate to more like a logic semi name (~15x ex-cash).