Is Sandisk Stock a Buy on Surging Revenue and New Contract Structures?

Sandisk's (NASDAQ: SNDK) strong momentum continued as it once again reported surging revenue and significant gross margin expansion in its fiscal Q3 earnings results at the end of April. However, perhaps the most exciting news to come out of the quarter was that the flash memory maker has begun signing long-term contracts.

Sandisk has been a huge beneficiary of surging NAND (flash) memory prices, as demand has outstripped supply. This is the result of the big three memory makers cutting NAND production and turning their focus toward DRAM (dynamic random access memory), following a market collapse a few years ago, and then the rise of artificial intelligence (AI) data centers, leading to the sudden need for massive, high-performance solid-state drives (SSDs) using flash memory to hold training data.

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These dynamics have helped power Sandisk's stock to rise 422% this year, as of this writing. However, despite the gains, the stock only trades at a forward price-to-earnings (P/E) ratio of 7 times fiscal 2027 analyst estimates. The reason is that the flash memory business has historically been highly cyclical, with large boom-and-bust cycles. That is why the revelation of its longer new business model (NMB) contracts is a big deal.

Rapid growth continues for Sandisk

For its fiscal Q3, Sandisk's revenue soared 251% year over year to $6 billion. Data center revenue skyrocketed 645% to $1.47 million, driven by AI data center expansion and a shift to triple-level cell (TLC) SSDs. Its Edge segment, which includes smartphones and PCs, saw revenue jump 295% to $3.7 billion, while the consumer segment, which consists of things like flash drives, saw revenue climb 44% to $820 million.

The revenue growth was led by higher NAND prices, which also greatly boosted the company's gross margins. For the quarter, gross margins climbed from 22.5% last year and 50.9% in fiscal Q2 to 78.4%. The company's adjusted earnings per share (EPS) flipped from a loss of $0.30 to a profit of $23.41. That's well above the adjusted EPS of between $12 and $14 it previously forecasted.

Looking ahead, Sandisk management guided for fiscal Q4 revenue to be between $7.75 billion and $8.25 billion, up from $1.9 billion a year ago. Gross margin is expected to be between 78.9% and 80.9%, up from 26.2% a year ago. Adjusted EPS, meanwhile, is forecast to soar from $0.29 to between $30 and $33. Yes, that's a more than 10,000% increase.

The big news, though, was the introduction of its new NBM agreements, with the longest extending for five years. The company signed three of them in the quarter, and then two more after the quarter ended, for a total of five. The three Q3 contracts are for a minimum of $42 billion and are in its backlog. The contracts are also secured by $11 billion in guarantees managed by third-party financial institutions that would get triggered if the contracts were not fulfilled.

The agreements include both fixed and variable pricing, and management said they will cover over one-third of its BiCS (bit-cost scaling) production next fiscal year. BiCS is a 3D type of flash used in SSDs, with newer versions of the technology developed in partnership by Kioxia (formerly Toshiba) and Sandisk.

Can Sandisk stock's upward momentum continue?

The biggest knock on Sandisk has been the cyclical nature of its business, but with its new NBM agreements, the company is looking to increase visibility and reduce some of the cyclicality of its business. Signing five customers to these contracts is a big step, and it is expected to sign more NBM agreements in the coming months. That says a lot about the current state of the flash memory market.

Meanwhile, Sandisk is currently enjoying a huge NAND supercycle that shows no signs of slowing down. It's generating huge free cash flow, which has allowed it to become debt-free and now start a huge buyback. With the stock still cheap and Sandisk working to create a less cyclical business model, this AI stock looks like it still has upside ahead.

Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.