(By Mani) Shares of SanDisk Corp. (NASDAQ: SNDK) could be pressured due to elevated risks of oversupply in the first quarter of 2013. The recent upward momentum in NAND pricing could slow in the face of an uncertain macro-environment that is stalling better-than-expected demand. Many electronic devices, including MP3 players, use a type of flash memory called NAND.
In this scenario, consensus estimates for the first quarter and fiscal 2013 appear too bullish as it does not account for the first quarter oversupply risk to pricing. Wall Street expects earnings of 63 cents a share on revenue of $1.36 billion for the first quarter, according to analysts polled by Thomson Reuters. For fiscal 2013, analysts estimate $3.43 a share on revenue of $6.01 billion.
"We believe consensus estimates could reset lower once Q1 oversupply becomes more transparent. While like-for-like ASPs may rise in the near term, there is still a risk that ASPs decline, reflecting a higher mix of retail bits," RBC Capital Markets analyst Doug Freedman said in a note to clients.
There is a risk to both OEM and retail market ASPs as short-term pricing contracts remain the norm. The potential uplift in Apple Inc. (NASDAQ:AAPL) or Samsung product cycles may not be large enough to offset the impact from slower trends across the remainder of the retail and consumer markets.
In the first quarter, softer seasonal demand would pressure NAND pricing and margins, particularly in a retail market that accounts for 41 percent of sales. Supply rationalization will become more transparent in 2013 for the NAND industry, as lowered bit-growth forecasts will support a strong solid-state drive (SSD) and mobile adoption cycle.
"We believe that the vast majority of NAND end-markets will be exposed to softer demand trends through the next five months. While the pace of cost reductions slow, we believe industry margins are well positioned to expand as the slope of ASP degradation is less draconian vs. past years," Freedman noted.
Meanwhile, the internal supply output plan in 2013 is a risk to market share and margins. SanDisk expects 2012 industry bit growth of more than 60 percent compared with prior expectation of 70 percent as the company is taking market share with an expectation for 80 percent-plus captive supply growth.
For 2013, SanDisk expects industry bit growth in excess of 30 percent to 40 percent, lower than an earlier projection of 40 percent to 50 percent. Contributing to the tightened supply environment is SNDK's decision to not ramp phase 1 production at fab 5 until second quarter 2013, at the earliest.
However, the company's plan to run at the lower end of industry growth given greater 2-bit/cell mix, extended 24nm product cycle, and timing of incremental fab ramps may hurt the market share.
"The first problem is that the company could be positioned to lose market share as SNDK output will not be able to keep up with the industry. The second problem is that should SNDK gain market share, it will be by using lower-margin non-captive bits (we estimate around 15% gross margins) to meet demand," Freedman wrote.
In addition, SanDisk is increasingly responsible for market pricing behaviors; this is an issue that certainly plagues the entire NAND industry.
"Our view is that SNDK and other NAND vendors should place pressure on OEMs to engage in longer-term contract negotiations in order to stabilize market prices and remove allocation risks. In today's market, we believe contract negations do not exceed a one-month window," the analyst wrote.
The shorter contract duration allows OEMs to time market purchases, thereby taking advantage of the seasonal fluctuations in NAND pricing. A more assertive move to longer-term contracts, 6 months to 9 months, would support higher prices as it would smooth or remove the impact of NAND price volatility and ensure allocation.
The reluctance by SanDisk to develop long-term contracts with key mobile customers continue to leave the industry vulnerable to seasonal pricing swings, where the first quarter is typically the weakest and sets the floor for full-year margin levels.
For the third quarter ended Sept. 30, 2012, the Milpitas, California-based company earned $76.5 million, or 31 cents per share, lower than $233.3 million, or 96 cents per share, for the year-ago quarter. Excluding items, it earned 48 cents per share, topping the Street view of 33 cents per share for the third quarter. Total revenue for the third quarter fell 10 percent to $1.27 billion, while analysts' consensus revenue estimate was $1.22 billion.
"We advise investors to be on the sidelines until a more attractive entry-point surfaces, possibly in late Q1 or early Q2, before trying to play secular growth from SSD ASP demand elasticity," Freedman added.