Investors and techies have been captivated by the surplus of leaks and rumors about Apple’s yet-to-be officially announced new products. iPhone 6 specs appear to be the worst-kept secret from Cupertino to Taiwan. For years, investors have also been trying to game what component suppliers are “in” Apple’s next gizmo with the thought that this will bring great riches for the coveted few. Apple suppliers are sworn to secrecy about the involvement until the actual product release, and even then it often takes a tear-down of said device to reveal the components.
Last night, one such well-known Apple supplier, Sandisk (SNDK), provider of flash storage solutions, reported Q2 results that were slightly better than consensus but guided gross margins down for the second half of the year. The stock is trading down 11.5%. Apple is a 20% revenue contributor, and as it ramps up production of new iOS devices that are sure to have greater storage needs, Apple will be displaying their legendary power to squeeze component suppliers on price.
There are many smaller companies who need Apple to demonstrate the validity of their products and are willing to make concessions. Because of that, it is a difficult decision for larger suppliers like SNDK to trade profitability for scale and market share.
Analysts are defending SNDK margin guidance, with many suggesting that they are overly pessimistic given the supply/demand environment for NAND in the second half of 2014. Yet from where I sit, after a cyclical company like SNDK has enjoyed a fairly healthy margin rebound in the last two years, back to peak margins, it is probably worth taking the company’s guidance at face value. The ten year chart below shows the steep decline in 2008/2009 and then the sharp rebound in 2010 that corresponds with the birth of the tablet segment, and then the 2012 decline and the recent rebound:
The gross margin decline in 2011 to 2012 corresponded with year over year earnings decline of 50% from peak earnings. That’s called operating leverage folks, and SNDK has got a lot of it. That bodes quite well for the stock when margins are rising, but can sting quite a bit on even small declines. As many long time tech investors know, when gross margins reverse from peaks, it is not usually a one off event, which could be one of the main reasons for this morning’s dramatic declines.
SNDK broke out to a new all-time high in May, moving cleanly above the highs from 2000 and 2006:
The stock is trading around $100 on today’s open, still up more than 40% year-to-date. The valuation does not look rich, but the real question is whether the lowered margin guidance portends an eventual EPS decline as well. At the same time, SNDK has tripled in the past 2 years, so perhaps some healthy selling from weak hands to strong hands was in order anyways.