Friday, September 18, 2009

Sandisk (NASDAQ:SNDK): Upgraded to Buy at Merrill Lynch; $30 tgt

Merrill Lynch/BAM is upgrading Sandisk (NASDAQ:SNDK) to Buy from Undererform with a $30 target (prev. $9.90).

According to the firm the new price target is derived from the average of our mid- and up-cycle fair values (vs. the average of trough- and mid cycle fair values previously). They target about 2x P/BV (PO implies 1.7-1.8x based on 2010-11E) vs. 2-4x during mid- and up-cycle periods (2002-07) or 1-2x in the recent downturn (2008-2009). Firm is no longer bearish on SanDisk. They now expect a solid earnings recovery in 2H09 and 2010-11. Merrill's new forecasts for OP and EPS indicate an almost up cycle level of earnings through 2010-11 – surpassing the previous upturn average (2006-07) but slightly lower than the 2005 peak. They revise their EPS estimates by more than 100% due to dramatic changes to ASP assumptions for SanDisk’s flash card products (about 30-40% higher for 2010-11 on a better supply and demand outlook for NAND chips).

Tight NAND supply presents new catalyst
SanDisk differs from typical OEMs such as Apple due to its captive chip production (JV fabs with Toshiba) and the option to purchase chips from Samsung. Consequently, the best case scenario for SanDisk should be a NAND shortage. Merrill's research shows tight supply of NAND due to chipmakers’ record low capex spending in 2009-10. Against this backdrop, they raise their ASP assumptions for SanDisk’s products by 30-40% for 2010-11, leading to EPS revisions of over 100% on a higher OPM (15-17% in 2010-11 vs about breakeven previously).

Financials and technologies look good.
Financial distress no longer concerns Merrill. SanDisk’s B/S remains healthy (over US$1bn net cash including long-term financial investments), despite large losses in 2H08-1H09. They also note the successful deployment of new technologies such as 3-bit cell (vs. MLC) and 32nm (vs. 43nm) – about one or two quarters ahead of Samsung. Firm thinks Korean chipmakers will focus more on DRAM capacity expansion vs. NAND due to relatively better margins and market share gains at the expense of Taiwan DRAM vendors. This also suggests upside to NAND.

Potential profit taking shouldn’t be a concern
SanDisk’s share price has doubled YTD along with NAND price strength. This may lead to profit taking among investors who bought the stock early this year. However, the current share price reveals low P/BV multiples (1.5x based on 2009E book) vs. its historical average (2.2x during 2002-07). The stock traded at 1x P/BV during the deep downturn in 2H08/1Q09, but Merrill's new forecast suggests better than mid level of earnings momentum or even higher than the previous upturn period (2006-07). Therefore, they think any profit taking driven stock price correction would offer a good entry point for new investors.

3Q results will be an earnings surprise?
Yes, Merrill expects SanDisk’s OP to exceed consensus (their estimate: US$138mn vs consensus: US$52mn) on upbeat ASP and well-deployed new technologies in JV fabs.

Notablecalls: Should cause a bit of a stir here. NAND players shut investments down which drives profitability (supply glut creating pricing upside). Hence the expected 'beat & raise' cycle.

Will it last? No way. History has taught us that the hard way. already.

I think SNDK can trade up 1.5-2 pts on this. After all, it's MLCO and $30 tgt.

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