Merril Lynch
Western Digital Corporation Stock discounting zero contribution from NAND Flash; Reiterate BUY Reiterate Rating: BUY | PO: 92.00 USD | Price: 54.42 USD
Missing the forest for the trees: WDC down 49% in 7 mths WDC has declined 49% since its recent peak mid-March (+5% for S&P 500), as investors are discounting a sharp decline in NAND margins and expectations of peak earnings. We take a holistic view of the memory market and estimate that significant Exabyte growth is needed from both HDDs and Flash to satisfy storage needs, but with revenues shifting towards Flash (despite significant price decline). There remains near term NAND pricing risk for the stock and Street estimates are still too high, but our SOTP shows that investors are valuing the Flash business at essentially zero, and well below 4x for Micron; Buy.
Expect pressure on quarter/guide We believe WDC will report F1Q19 (Sep) revs/EPS that reflect continued pressure from the NAND business, and expect F2Q19 (Dec) EPS to be well below the Street’s $3.06 (we model $2.71), from gross margin deterioration. However, we expect the NAND GM% to stabilize by mid-C2019 (beginning F2020) as supply-demand comes into balance and pricing declines ease on a Y/Y basis. Even with our conservative view and NAND GM% going from 44% in C18E to 34% in C19E, WDC could earn over $10 in EPS.
SOTP analysis suggests deep discount to NAND business Our sum-of-the-parts (SOTP) analysis on WDC based on Bear, Base, and Bull case scenarios yields $92 as our Base case. Conversely, at current stock price, subtracting a 10x HDD EPS for C19E, implies an effective zero value for NAND Flash, which is baking in an unrealistically pessimistic scenario. We lower our revenues/EPS estimates, taking a more negative view on n-t NAND pricing, but the l-t thesis is unchanged. Our PO also goes to $92 on approx. 9x C19E EPS of $10.09 vs Street at $11.37 (prior 10x).
HDD revenues stabilize; Flash remains in secular growth We expect HDD industry revenues to stabilize at the $24 billion level, flattish from the C2017 level of $24.3bn (0.3% C2017-2020 CAGR). Underlying this is a shift to High Capacity HDD drives that are benefitting from overall data generation and storage growth. On the NAND Flash market, the expected growth in Exabyte from 188 EB in C2017 to 472 EB in C2020, a 36% CAGR, should drive a 6% revs growth CAGR.
Sum-of-the-parts (SOTP) P/E analysis & Bull/Bear We do a sum-of-the-parts (SOTP) analysis on the Western Digital model, segregating the HDD and SSD/Flash/Storage businesses. For the HDD business, we estimate an EPS contribution of $5.47 for C2019, while for the SSD/Flash portion (which includes WDC current SSD portfolio) we estimate an EPS contribution of $4.62 in the Base case scenario. Note, the Flash EPS contribution includes our estimate for a cyclical downturn in the segment, and is down from $8.83 in C2017 (see in Figure 1). Our implied stock price for WDC based on Bear, Base and Bull case scenarios and multiples ranges from $61 to $150, and is based on 9.0x-11.0x HDD contribution plus 6.0x-10.0x Flash contribution. In the Base case scenario we get to a price objective of $92. |
