Barron's article about the JPM coverage that I received in my eTrade account.
DJ Tech Trader Daily: Why Western Digital Can Gain 45% Despite Declining Business -- Barron's Blog
May 14, 2018 14:44:00 (ET)
By Jack HoughWestern Digital (WDC) stock is barely changed from two years ago, even though earnings per share have tripled over that time. That makes the hard drive maker, by one measure, one of the cheapest big companies in America: it recently traded at six times forward earnings estimates, or about a 40% discount to the Standard & Poor's 500 index.
Time to buy shares, writes JPMorgan analyst Harlan Sur in a recent report initiating coverage. His target price is $120 by year's end, for a gain of more than 45% from recent levels. The prediction implies that shares will rise to nine times projected earnings for the fiscal year through June 2019. Compared with recent history, that's not especially far-fetched. Shares have traded at nine times earnings, on average, over the past five years.
The stock's stallout in recent years is owed to a one overarching concern: hard disk drives are rapidly losing market share to solid-state drives, which boast much faster speeds and lower power consumption. Last year, in fact, the SSD market took the lead, growing 48% to $25.1 billion, while HDD shrank 3% to $24.3 billion. In SSD, Western Digital is tied for No. 2 in market share with Intel (INTC), at 13%, behind runaway leader Samsung Electronics (005930.Korea), at 40%. But the HDD market is a near-duopoly in which Western Digital edges out Seagate Technology (STX).
That means Western Digital's heaviest exposure is to a declining market. At the same time, prices for the flash memory underlying SSD drives are expected to fall over the next year. During Western Digital's latest earnings report, it guided to lower gross profit margins for the current quarter through June. So even though adjusted earnings last quarter jumped by more than 50% and beat estimates by 10%, shares lost 8% in a day following the report.
The good news for Western Digital is that HDD still offers 10 times the storage capacity of SSD per dollar of cost. That means that while HDD might be falling out of favor for personal computers, it remains in demand for cloud computing, where demand for storage is ravenous, and buyers keep a close eye on their return on storage investment. Western Digital has a new HDD manufacturing technology called microwave assisted magnetic recording, which could help it reach drive capacities of 40 terabytes by 2025. Compare that with its largest model today, a 14-terabyte drive made with conventional manufacturing.
That means Western Digital stands to enjoy lavish free cash flow from its HDD business in coming years while participating in the growth of SSD, particularly among cloud computing customers. As for the falling gross margins, JPMorgan's Sur points out that those are pretty typical for this time of year, owed in part to a higher mix of drives for gaming consoles, smartphones and personal computers. And near-term weakness in flash prices is offset by a bright outlook for long-term demand.
All of that means Western Digital's stock valuation could rise from dire levels to a discount more typical of recent years--rewarding deep value investors along the way.
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May 14, 2018 14:44 ET (18:44 GMT)
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