Deutsche Bank downgrades M-Systems to "Hold"
"The current market price fairly reflects both the growth prospects and associated risks."
"We are downgrading M-Systems to a non-consensus Hold rating on the view that the current market price fairly reflects both the growth prospects and associated risks," Harverd writes.
"We remain positive on the near term outlook for the company, but believe that at current levels the stock is already pricing in strong performance in both H2 2005 and 2006. While great emphasis has been placed M-Systems' growth outlook, there has been scant focus on the risks. In this report we attempt to re-address the balance and outline some long-term concerns.
"The growth of the USB flash drive market has been extremely rapid and accounted for nearly 70% of M-Systems' revenue growth in the last 10 quarters. However 2006 is set to represent an inflection point where market growth rates decline from 50%+ levels to 20%+. We view U3 as a natural evolution of the USB flash drive market whose main impact will be to drive demand for higher density drives rather than create a new category.
"We are extremely positive regarding MDOC's growth potential in H2, and believe there will be a multi-year migration to embedded NAND in cell phones. However, we do not expect this to lead to significant near term margin upside and raise concerns about long-term profitability anticipating an environment of ASP declines and margin pressure in the next few years. While we view MegaSIM as an important opportunity, the adoption rate is likely to be lengthy and there is a risk that expectations for rapid revenue ramp in 2006 may run ahead of themselves.
"We have increased our price target slightly to $26 as the market has begun to look ahead to 2006, but are taking a neutral stance on the stock since we believe growth to be priced in. We expect the 2006e earnings growth rate to moderate, so use a target multiple of 19.5x 2006e EPS, lower than our previous target multiple of 25x 2005e EPS. Our valuation is supported by a DCF model laid out in the report. The main upside risks are that MDOC revenue growth far exceeds expectations and that demand for USB drives continues to grow at a rapid rate. The main downside risk is that the company increases its cost structure in anticipation of higher growth rates than the market can support."
Published by Globes [online], Israel business news - www.globes.co.il - on August 16, 2005
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