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Bull of the Day: SMART Global (SGH)

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I last wrote about SMART Global Holdings (SGH - Free Report) in late March after they delivered another earnings "trifecta" of sales and profit beats and raised guidance.
 
In that report, I compared the small-cap to its giant peer in the computer and mobile DRAM and NAND flash memory industry, Micron (MU - Free Report) . I'll make some fresh comparisons later in today's report, right after we talk about why SGH shares were up over 25% on October 5.
 
Because SGH just did it again, and in a month when the broad market melted down over 5%, SMART is up over 10% from depressed valuation levels under $30.
 
On October 4, SMART Global reported Q4 FY18 results (ended August) and delivered yet another earnings triple-threat with top and bottom line beats and solid upward guidance. Plus the new supercomputer/datacenter division won new contracts with the US Department of Defense and the Department of Energy!
 
Quarter Details 
 
SGH reported Q4 (FY18 ended August) adjusted EPS of $1.72, $0.06 better than the Zacks consensus estimate of $1.66. Revenue for the quarter came in at $374 million versus the consensus of $369 million. 
 
Management guidance sees Q1 EPS $1.74-$1.79, vs consensus of $1.69 and Q1 revenue $375M-$390 million, vs consensus of $381.5 million. Sees Q1 gross margin 22%-23%.
 
“We completed fiscal 2018 with another great quarter, including the closing of our acquisition of Penguin Computing,” commented Ajay Shah, Chairman and Chief Executive Officer. “In addition, we closed our first full fiscal year as a public company with record revenues that crossed the $1 billion mark.
 
"Driving this performance was strength in our Specialty Memory business which had a very strong quarter and earned new NVDIMM and VLP RDIMM design wins at major Storage and Server customers. We also had design wins for our ruggedized SSD products and our Embedded Data Cache product in the Industrial Automation market. Brazil continued its strong performance and added many new memory products for PC, server and smartphone applications as well as a new polymer cell-based battery product for smartphones.
 
“Our new Specialty Compute and Storage Solutions business led by Penguin Computing performed well in its first quarter as part of SGH. During the quarter we won a number of key contracts with agencies within the Department of Energy (DoE), contractors to the Department of Defense (DoD) and with a number of other enterprise customers for our HPC and AI cluster products.”
 
Analyst Reaction
 
Deutsche Bank and Roth Capital Partners analysts were both pleasantly surprised by these results. But both also lowered their price targets to $50 and $60, respectively, while Stifel pounded their big bullish stake further in the ground with a flag-waving raise from $61 to $62.
 
In a post-earnings research note titled "More stable than feared," Deutsche Bank analyst Sidney Ho says Smart Global's guidance for in-line revenue and slightly better earnings should ease investors' fears that the weakening memory industry will lead to sharp estimate cuts. The analyst is encouraged by the company's confidence that the second half of fiscal 2019 should see strong seasonal growth driven by both Penguin and Brazil Mobile Memory businesses.
 
Ho believes this strength highlights the difference in business model between Smart Global and memory component suppliers such as Micron Technology (MU - Free Report) . Ho lowered his price target for the shares to $50 from $60 but keeps a Buy rating on the name. He notes Smart Global trades at only four times his revised 2019 earnings estimate. 
 
Roth Capital analyst Suji Desilva maintained a Buy rating on Smart Global but cut his price target to $60 from $70. Noting that SGH represents a differentiated investment opportunity, Desilva told investors that results and guidance in the quarter both came in ahead of consensus, reflecting continued strong execution across key segments despite broader concerns about a memory demand cycle. Recent weakness in Smart Global shares represents a "mispricing" that assumes the company is exposed to a cyclical memory downturn, he says. 
 
Jefferies analyst Mark Lipacis said that the SGH beat and raise exhibits strong growth in the franchise. Plus, the company appears to be successfully integrating its Penguin computing acquisition, which he thinks provides another secular growth element and diversifies its revenue stream. "SGH's P/ E multiple has compressed to 4X from 10X over the past 12 months as Street concerns about the semiconductor cycle have elevated. With a P/E now under 4X, we think the risk-reward ratio is particularly attractive."
 
The Big Bull Speaks
 
Kevin Cassidy and his team at Stifel, the unfaltering and biggest Street bulls on SGH, probably felt as vindicated as I did when shares launched 25% from $27 after earnings. 
 
They highlighted SMART's diversification strategy as key to delivering sequential growth in all product lines that "may confound short sellers." And addressing the concerns about the memory glut/demand slowdown, here's what they had to say... 
 
Management explained that most of their memory modules use trailing edge devices (DDR3 DRAM and SLC/MLC NAND Flash) which are less susceptible to price fluctuations. Importantly, with memory OEMs expanding leading edge capacity in new facilities, DDR3 and SLC/MLC availability has improved.
 
Cassidy and Co. were also very encouraged by the progress with Penguin Computing. They look forward to learning more details on this business during the Super Computing 2018 conference in Dallas, November 13-15. They continue recommending SGH shares and raised their PT an "in your face bears" buck from $61 to $62.
 
The Little 'Ole Success Story You Never Heard Of
 
Even though they've been in business for 30 years, SMART just IPO'd in May of 2017 at $12. And given its growth trajectory, that was an unbelievable steal.
 
For FY2019 (ending next August), SGH is now expected to grow the topline over 22% to $1.57 billion from FY2018 sales of $1.3 billion -- which was 48% growth! With a $700 million market cap, that gives the stock a very attractive Price-to-Sales ratio of under 0.5X.
 
Part of the big revenue growth is all about Brazil right now as their economy recovers and consumer demand for digital electronics picks up.
 
But the company also has manufacturing locations in a half-dozen other cities around the globe. Founded in 1988 as Smart Modular Technologies, SGH corporate headquarters are in Newark, California and the company employs over 1,100 people.
 
The company now exists as a holding company for various subsidiaries across its world-wide memory manufacturing and supply chain services.
 
There is an R&D center in Tewksbury, MA and a European Planning & Sales Center in East Kilbride, Scotland. There are sales centers in Hong Kong and Singapore and an Advanced Package Engineering and R&D center in South Korea.
 
From these locations, SMART serves a rich list of industries and applications, including automotive, communications, computing, defense, gaming, industrial, and the cloud.
 
SMART vs. Micron
 
So why do investment banks have an average target price on SGH of $57 and why does the stock seem to be stuck near $30?
 
First off, it's all about the growth and value I have described. And EPS wise, SGH is expected to earn nearly $7 into 2019, putting its forward P/E multiple near 4.5X at $32. Analysts think this growth is worth a 8X multiple at least. 
 
Secondly, as I've written repeatedly, another bigger reason for investors and analysts being so far behind on the SGH growth story is probably some measure of subdued optimism because those banks model the valuation similar to giant "peer" Micron which historically trades between 6X and 8X forward EPS.
 
But Micron is a $50 billion enterprise trading at over 1.6X sales.
 
Whereas SGH is a sub-$1 billion company trading at under 0.5X sales estimates -- and, more importantly, with a higher double-digit growth rate.
 
Indeed, SGH could be an acquisition target for the behemoth of memory.
 
But I hope it grows and trades a lot higher before it becomes anyone's target.
 
Disclosure: I own shares of SGH and MU for the Zacks TAZR Trader portfolio.
 
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