Looks good from Alpha!! enjoy..Western Digital: Buy On The Drop?
Aug. 24, 2016 6:22 AM ET
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About: Western Digital Corporation (WDC)
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Summary
Western Digital is down more than 40% over the past 12 months and 12% from late July.
The market is pricing in some uncertainty with the SanDisk acquisition.
I think WDC represents good value at current prices, due primarily to SanDisk.
I rate Western Digital a Strong Buy on the drop.
Introduction
This article is my 39th installment in a segment called "Buy on the Drop?" in which I choose a stock that recently experienced a large decrease in price and give a recommendation on whether investors should "Buy on the Drop" or not. The recommendations are Sell, Hold, Speculative Buy, Buy, and Strong Buy. This is a recurring segment, so if you enjoy the article, "Follow" me to see more. You can read about my previous installment discussing J. M. Smuckers (NYSE: SJM) by visiting my author page.
Western Digital Gets Bricked
It has been a difficult last couple of years for Western Digital Corporation (NASDAQ: WDC) shareholders as the stock has essentially been a on a straight downward trajectory since the beginning of 2015. Over this period, WDC has lost nearly 60% of its value:
WDC data by YCharts
This decline mirrors the parallel decline in the hard disk drive ("HDD") market, which is now in what I, and many others, believe to be a terminal descent. Desperate times call for desperate measures, and so in response to the deterioration of its core market, WDC made a blockbuster acquisition of SanDisk to buy into the solid state drive ("SSD") market that has become the new growth driver of memory.
Back in early May 2016, I wrote an article on Western Digital claiming that the stock was a contrarian value play that held high potential upside due to the SanDisk acquisition. That article can be read here. Just a week after that piece was published, Chinese regulators signed off on the deal and the acquisition closed. Now we have the combined entity selling both HDDs and flash memory valued at about $11 billion. In this article, I will assess Western Digital to determine if the current valuation is too cheap for what's under the hood.
The most recent sources of WDC shares' woes was the company's fourth quarter report, which sparked a selloff of more than 12%. Operating expenses ramped up due to the SanDisk acquisition, resulting in a GAAP net loss, and general investor uncertainty was abound. However, after looking at the results, I think WDC is on the right track for long-term success.
Before moving I would like to explain that I think using non-GAAP numbers is more informative than GAAP measures for merger-related accounting. The non-GAAP EPS numbers give a more accurate portrayal of the company's business operations during the quarter, and do not include the one-time expenses and costs that are incurred during the transitionary period. This is not to say that the costs should not be accounted for, but I think the non-GAAP numbers provide better insight into how the combined entity will perform going forward.
In the fourth quarter 2016 press release, WDC reported revenue of $3.5 billion, which beat consensus estimates by $40 million and was up 9% year-over-year ("YoY"), non-GAAP EPS of $0.79, which beat by 8 cents, and non-GAAP gross margin was 31%. The latter two figures are not particularly impressive, but they are short-term consequences of the SanDisk acquisition. Operating expenses were $691 million in Q4, up 45% sequentially from Q3, and with little in the way of cost synergies between Western Digital, an HDD manufacturer, and SanDisk, an SSD manufacturer, the operating cost savings may not be too significant. Operating expenses are expected to balloon in Q1 2017 as well, to $875 million as the quarter will fully include SanDisk's expenses in contrast with only partial inclusion in Q4.
Regardless, with the HDD market moribund, the acquisition was a must. And despite the current combined entity's unwieldy structure and organization, the business is still running smoothly enough. Free cash flow for the quarter was $141 million, WDC is preparing for the launch of 3D NAND in 2017 with additional capacity expansion, and the company guided for first quarter 2017 non-GAAP EPS between $0.85 and $0.90 on revenues of about $4.45 billion.
Though FY2017 will surely be a bit hectic with SanDisk's ongoing integration and therefore increased operating expenses, I think the results from Q4 2016 provide reason to be bullish about WDC going forward. Even if absolutely no more operating improvements or growth were factored into the three quarters of 2017 following Q1, meaning EPS stays the same, FY2017 EPS would still come out to about $3.50, which would put WDC at a bit over 13x 2017 earnings.
I expect that to be a conservative estimate as, despite the differences in business models, there is always room for optimization on the cost side. CEO Stephen Milligan acknowledged this fact on the conference call, stating that core operating expenses would begin to come down following Q1 2017 as synergies are realized. Additionally, revenue growth is likely to ramp up as well as the HDD market has hit a bit of a bottom for the time being (likely not very long) and 3D NAND shipments will begin in first half of calendar year 2017 (Q3 and Q4 2017).
At $10 billion, Western Digital seems like a bargain right now. With the combined revenues of WDC and SanDisk, the company is trading at what I expect will be about 0.5x 2017 revenue and about 13x 2017 earnings (conservatively). Strangely enough, In recent months WDC has been outdone by Seagate Technology (NASDAQ: STX), which still derives about 95% of revenue from the HDD market. Western Digital has much better positioning for the future than Seagate, and I expect the market to pick up on this as soon as the merger-related issues stop obscuring the real value of the company.
I think WDC is a bargain at its current valuation and that investors may be wise to pick up shares. The potential upside cannot be ignored by the market for very long, though increased expenses may obfuscate fair value for a few quarters. I think WDC made the correct long-term move by acquiring SanDisk and expect this will strengthen the combined entity in the crowded memory space. WDC's HDD sales and profits will be the cash cow for the next few years while SanDisk provides the growth. Due to the strength of the company's fundamentals, the low current valuation, and a nice dividend yield of about 4%, I rate Western Digital a Strong Buy on the drop.
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Thanks for reading!
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WDC over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. |
