Quarterly earnings released by several key suppliers of components used in devices such as smartphones and tablets illustrate a point investors should always remember. Even though the mobile market is hot, companies making critical components don’t always reap the same benefits as those that ultimately stamp their names on the devices.
- Sudden demand for a new product leading to customers seeking alternative suppliers if production capacity isn’t fully ramped up
- Competition as other companies move in on a hot market
- Price pressure from customers
- Production overcapacity and a resulting glut of components.
So, although their fortunes may be loosely tied to the likes of Apple (NASDAQ:AAPL) and Samsung (PINK:SSNLF), record sales for mobile devices doesn’t always translate into good times for the companies that make the parts.
Take SanDisk, a leader in NAND flash memory products, including thumb drives, memory cards and solid-state hard drives. NAND flash demand has increased significantly in the past several years, thanks to the popularity of mobile devices, with Apple alone expected to buy one-quarter of the world’s NAND flash production for 2012. Rather than resulting in good times for SanDisk, that demand has resulted in competitors like Samsung, Micron (NASDAQ:MU) and Toshiba (PINK:TOSBF) bringing additional factories online, leading to an industrywide oversupply.
In addition, the demand for solid-state drives that many expected after floods in Thailand disrupted supplies of traditional hard disk drives never really materialized. Solid-state drives remain too expensive to be a mass market substitute.
While SanDisk had previously predicted sales for the quarter of $1.3 billion to $1.35 billion, it subsequently revised guidance on April 3, calling for earnings in the $1.2 billion range. Its stock subsequently took a 7% hit. The final results, released on April 19 were for $1.2 billion revenue (down 7% year-over-year and a 24% drop from the previous quarter) and earnings of 63 cents per share. Wall Street had been expecting earnings in the 70-cent range. The company also predicted lower revenue into the second quarter ($950 million to $1.05 billion), well below the $1.3 billion previously expected.
Among the factors SanDisk cited for its poor performance were excess inventory, competitive pricing pressure, increased costs due to the rise in the Japanese yen and lower demand due to general economic weakness in its markets.
The reaction from investors was swift, with SanDisk stock dropping another 13% on Friday morning. While there’s potential for uptake in solid-state drives if Intel’s (NASDAQ:INTC) Ultrabook initiative gains steam this year, the models used in these ultra-compact notebooks tend to be lower-capacity, lower-performance versions — the closest thing to a low-profit-margin “commodity” drive. So, not much of revenue silver lining is likely here. Look for SanDisk to be an underperformer for the rest of the year.
Qualcomm, a manufacturer whose broad band chips and processors are a key component of smartphones, including models from Apple and those running Google‘s (NASDAQ:GOOG) Android operating system, rode the wave of increasing consumer demand for mobile products to beat analyst estimates for its second quarter results, posted on April 18.
On the other hand is Qualcomm, whose record-breaking quarter included revenue of $4.94 billion (up 28% over the previous year) and net income of $2.23 billion (up a whopping 123% from a year ago). Diluted earnings per share were $1.28 (up 117%). According to The Wall Street Journal, Qualcomm chips are currently used in 370 different devices, with 400 more coming online.
So, why did investors react by cutting Qualcomm’s share price?
First of all, that huge increase in net income isn’t repeatable — a good chunk of it ($1.2 billion) came from selling off its 700-MHz wireless spectrum to AT&T (NYSE:T). The second issue is more problematic for the coming year. Samsung, one of the biggest mobile device manufacturers, has been making noise about cutting reliance on suppliers, including moving away from Qualcomm-designed products and replacing them with its own chips.
The third bit of bad news for investors is Qualcomm’s warning that its factories may not be able to keep up with chip demand — particularly the Snapdragon processor used in many Android smartphones — potentially resulting in shortages and increased costs. The company projected sales in the quarter ending in June in the $4.45 billion to $4.85 billion range.
This issue is particularly troublesome because it opens the doors for competitors to fill the demand if Qualcomm can’t meet it, and that could hurt customer relationships, especially if smartphone hardware has to be reengineered to work with alternative chips.
If, as rumored, Apple’s next iPhone uses a 28nm Qualcomm LTE chip for its 4G wireless capability (which uses the same new manufacturing process as the Snapdragon processor-on-a-chip), news of the production challenges could impact the highly anticipated smartphone’s release date.
Shares dropped to $63.61 after the earnings report (a near 6% loss).
As of this writing, Brad Moon did not own a position in any of the stocks mentioned here.