Name That Trade – $SNDK: Flash Forward

by Dan September 2, 2014 3:29 pm • Commentary

While social media stocks have garnered a lot of attention in the recent leg of the bull market, both for booms and busts, it has been the less sexy nuts and bolts of technology, like semiconductors, that have demonstrated stalwart status on the leadership front.  The Philadelphia Semiconductor Index (SOX) is up 20% so far in 2014, and up 40% in the last year, doubling the year to date return of the Nasdaq Composite, and besting the 52 week performance by 10%.   Components of the semi sector are the annoying things you contemplate upgrading when building your PC online, like cpu, memory/storage etc.. yes I almost lost you there.   These are commodity products whose prices are most affected by supply and demand, think ramp of product cycles like entire new categories like tablets/wearables, secular shifts from hard drives to solid state storage or merely new upgrades of existing products.  It appeared that both desktop and mobile computing witnessed the perfect storm for component suppliers over the last year or so, with many companies finding themselves in the fairly unique position of having a bit if pricing power which has been a boon to profits.

For instance Sandisk (SNDK), the manufacturer of Nand flash storage, has seen an earnings boom and bust in the past three years, with peak earnings of $4.65 in 2011, to $2.38 in 2012, and back to a new peak of $5.31 in 2013.  Since making a fairly epic double bottom in 2012, SNDK shares rose 180% to the highs just put in back in July:

SNDK 2yr chart from Bloomberg
SNDK 2yr chart from Bloomberg

Back in mid July, SNDK reported what looked to be a strong Q2 but a 3% point margin decline. (likely the result of aggressive pricing demands from Apple as they ramp production of many new products) Pricing pressure goes both ways, as a company like SNDK will have to give up a certain amount of profitability to secure a greater % of a coveted customer’s business (Apple is about a 20% revenue customer of SNDK) .

Micron and SNDK are both down about 3% today on chatter of pricing concerns for both dram and nand, and the potential for a good bit of supply coming online. Like you, my sources in Taiwan are asleep (I have no way of verifying anything as it relates to pricing trends), but I will tell you that today’s negative price action in both stocks is on good volume and little hard news.  A continuation of this sort of price action by prior leaders could be a broader warning to large cap tech, that has essentially be infallible for most of 2014, even when many internet/social media stocks saw peak to trough declines of 20-50%.

While I am not sure this afternoon is a great entry on the short side for SNDK, I would suggest that the $100 gap level in mid July could serve as technical resistance for the time being, setting up for a decent consolidation trade in and around $90 or just about the low from last month:

SNDK ytd chart from Bloomberg
SNDK ytd chart from Bloomberg

Implied vol has seen a nice pop of late,rising from multi-year lows to the midpoint of the 52 week range, making options not particularly cheap for those looking to pick a direction:

SNKD 1 yr chart of 30 day at the money IV from Bloomberg
SNKD 1 yr chart of 30 day at the money IV from Bloomberg

So what sort of trade are we looking at?:

If SNDK were to see a bump back up in Q3 of gross margins I suspect buyers come back into the stock as the stock trades at 14.5x 2015 expected earnings and strong balance sheet with 29% of their market cap in cash, 20% net of debt, buy backs, and has a dividend yield of 1.25%.  The stock is not exactly cheap at a market multiple for a company that has had the sort of earnings volatility that SNDK has had, but does not screen as extremely expensive for a growth stock.

With an eye towards the elevated options prices, but also the technical set up with $100 serving as potential resistance, and $90 potential support on the next test of $100, and subsequent failure I would look to buy an in the money Put Fly playing for a move lower towards support, while also offering a very wide range of profitability to the downside.  For instance with the stock $95.80, the Oct 100/90/80 put fly costs about 3.20, offering a break-even that is in the money 96.80, with profit potential of 6.80 between 96.80 and 83.20, with max gain of 6.80 at $90 on Oct expiration. If I could enter that trade a little higher and possibly get it for closer to $2.50 I may pull the trigger.