Scott,
WDC is a puzzle to me. There just isn't any rationale for this kind of jump but then the market has been full of this kind of thing all year long. All I know for sure is I got stopped out of my short on it and am looking for the point to renew it. I suspect this rally may maintain a day or two longer.
This from Morgan Stanley Dean blah blah which I found to be uncharacteristically specious:
Gillian Munson Date: December 1, 1998
Type: Mkt Commentary/Strategy
______________________________________________________________________
STOCK THOUGHTS:
Disk drive stocks have supported a huge rally from their lows in early
September driven by strong PC demand trends. Disk drive stocks
(including all disk drive and component stocks) are up 93% on average
from their lows in early September. This rally has been more powerful
than that of the Philadelphia Semiconductor Index (SOX) which is up
68% from its low in early October.
We suspect that the disk drive rally has captured a lot of the good
CQ4 news and a chunk of the potential good news/upside for next year,
particularly given some of the more competitive industry issues on the
horizon in disk drives (i.e. too many players still have too much
capacity).
Moreover, while financial trends are improving, a good portion of the
improvements were already built into our models. We are having
trouble understanding how the disk drive stocks could be up more than
the semiconductor stocks when the HDD industry still faces huge
competitive issues and a more dicey pricing environment in C1999 than
does the semiconductor industry.
...however, if PC trends continue to be good and CQ1 is stronger than
expected, we could continue to be surprised on the upside - so for
now, more nimble investors should probably continue to ride out this
rally but be very careful. We must admit that the data points we have
gathered over the last two weeks support a more bullish case, and we
and the market are probably still a bit too conservative even though
market sentiment is catching up fast.
Drilling down, we think that the best disk drive-oriented investments
in C1999 will be companies that have specific earnings drivers from
new products, re-organization efforts, or acquisitions. Right now,
the companies that come to mind in this realm are Adaptec, Western
Digital, and Read-Rite.
While there may be some company-specific opportunities, our
conservatism on the group continues to be based on longer term
fears.and rests on the fact that we just can't get past the reality
that there are too many disk drive companies trying to gain market
share and that this competition could limit upside - we think that
investors will start to discount for this in CQ1. We are concerned
that there is not a technology that would cause players in the
industry to stumble and therefore limit supply and cause a naturally
better balance between demand and supply. Right now, we believe that
we might be right longer-term but still wrong near-term. If the GMR
transition turns out to be tougher than expected, we may upgrade some
of these stocks, as that could create a better demand/supply balance.
KEY POINTS
- Over the past two weeks, we have spoken to a number of our
company contacts and conducted channel checks in disk drives - simply,
the feedback was a bit more positive than we had expected.
- On the margin, CQ4 appears to be going better than expected for
most companies we cover (note that all already expected improved
demand and financials Q/Q) driven by strong PC demand.
- While we have caught up with a lot of companies in the last two
weeks, we had more detailed discussions with Western Digital (WDC,
$13, Neutral), Read-Rite (RDRT, $13, Neutral) and Adaptec (ADPT, $16,
Outperform, Target $20) who were all upbeat about their efforts to
improve their businesses. We believe that all three have actions
that they could take that can improve earnings with or without an
improvement in the market environment. In all three cases, the stocks
have rallied strongly.
- The key for the quarter in disk drives will be late-quarter
trends with PC OEMs. Right now, PC OEM (roughly 60%+ of disk drive
revenue) disk drive demand is good with a few increasing orders nicely
above plan. The real make-or-break issue will be whether or not PC
OEMs push back product late in the quarter if something in the sell-
through data scares them. This is an important point because late in
the quarter pricing and demand trends can make a BIG difference in the
earnings outlook for most of our companies. Right now, this looks
like it might go in the favor of the disk drive players and our
estimates might be too conservative for some companies.
DISK DRIVE CHANNEL FEEDBACK:
Disk drive channel feedback is positive. We have checked with a
number of our disk drive contacts over the past two weeks and so far
CQ4 demand looks good and sell out looks positive with low channel
inventory. We are seeing particularly strong demand at the very high-
end of the enterprise market and the low-end of the desktop. So far
in the quarter, our gray market contacts indicate that gray market
activity has been minimal - usually high gray market activity is a
sign that demand is not meeting plan.
For the first time in a long while, there are some mismatches of
demand and supply in certain capacity points on the desktop due to
lower channel inventory. The supply of 3GB and 4GB desktop products
is limited and customers want 3GB and 4GB products - therefore there
is a scramble to get these products and pricing at these capacity
points is stable. There is better supply of 6GB and 8GB products but
the prices are higher. Most expect 6GB and 8GB pricing to fall and to
drive demand that direction. We have a few contacts who are
indicating that the 6GB range products are starting to tighten up as
demand shifts up a capacity point. Interestingly, this issue
underlines how the disk drive industry is providing a lot more
capacity than customers really need. While customers are being driven
up today due to better than expected seasonality and a bit of a
scramble to keep up with demand, we think that this trend up is
unsustainable given organic demand for capacity points on the desktop
that are less aggressive.
SOME SPECIFIC COMPANY DETAILS:
Western Digital - Neutral
- Western Digital's management team continues to be quite upbeat
about the opportunity to improve financials and the stock is up 83%
since early October. Factory yields are improving with the 3.4GB and
4.3GB per platter desktop disk drives (3.4GB per platter is expected
to comprise nearly 50% of sales in CQ4) and as a result of better
quality, order rates are up. One issue the company faces is a product
transition in its high-end business (14% of revenue in CQ3). We
believe that it will take a couple more quarters to work through these
issues.
We believe that Western Digital will soon announce its first desktop
disk drive designed in conjunction with IBM. We believe that this
disk drive could have a capacity point of 5+GB/platter, will be GMR,
and will be very competitive on a time to market announcement basis.
The ramp for the product will be in CQ1 - maybe in January. We think
that if all goes well for Western Digital, this ramp will be very
competitive on a time-to-market basis. Western Digital believes that
this may be one of the only GMR-based desktops in high volume early in
the year.
Western Digital was also upbeat about some of the adjustments it has
made in management over the last few months. The most recent
announcement was the promotion of Russell Stern to SVP Strategic
Business Development, Marketing and Sales. As a result, Steve
Campbell will replace Russell in his position of SVP, Research and
Development, Personal Storage Division. Stern will be tasked with
looking at Western Digital's strategic direction and will oversee
worldwide marketing and sales operations. We believe that creating
this position means that Western Digital is seriously thinking about
the competitive landscape in disk drives and is contemplating what
that means for the company and its long-term strategy. We believe
that this implies that it would not be unreasonable to think that
Western Digital might expand its reach beyond disk.
Our CQ4 EPS estimate is ($1.08) on revenue of $722MM (down 26% Y/Y and
up 11% Q/Q), gross margin of 1.6% (vs. a gross loss of 0.9% in CQ3),
and opex of $106MM (up 23% Y/Y and up 5% Q/Q). We think that in an
upside scenario, Western Digital could post CQ4E EPS of ($0.90) with
better desktop disk drive dynamics - but it is still too early to
tell.
Read-Rite - Neutral
Conditions continue to improve for Read-Rite and the company is upbeat
about it's progress towards improving its financials, but the stock is
up 135% since the end of CQ3. For Read-Rite, near-term order rates
look good with at least one customer trying to get assurance that the
company will continue to ship in late December and into January. So
far the quarter is tracking.
One key hurdle that the company faces is the path of the Western
Digital and IBM technology alliance as Western Digital has represented
as much as 50% of revenue in the past. It appears that if Western
Digital were to release a desktop product with IBM, Read-Rite would
essentially lose out on the opportunity to sell recording heads to
Western Digital for that product. As Western Digital will make a
product announcement in this regard soon, this could be perceived as a
negative for Read-Rite, particularly given the big run in the stock
over the last two months. Read-Rite continues to work with Western
Digital to gain qualification on other designs - which to date, still
appear to be in the works.
We are at the high-end of the First Call range of a loss of $0.24 to a
loss of $0.11. We think that if order rates continue to stay strong
that Read-Rite could make our number. If not, we suspect that the
quarter will be somewhere in the range.probably in the middle.
Note that on November 24, 1998, Read-Rite announced that it had
completed qualifications on Maxtor's (MXTR, $14, Not Rated) 4.3GB per
platter hard disk drive. According to a press release, Read-Rite
began shipping the MR-based heads to Maxtor in volume last month, and
the heads are being shipped as fully assembled head stack assemblies
(HSAs).
Adaptec - Outperform, Target $20
- Adaptec's team continues to work to drive short-term profitability
and to position the company on a longer-term basis. Demand trends
appear to be good and the channel is clear. Moreover, the company
continues to look closely at its businesses to make sure that it is
streamlining its efforts. Non-core efforts will likely continue to be
sold or closed down.
The company continues to hold its view that SCSI will have a huge
opportunity over the next several years and that for now at least,
Fibre Channel will take longer to ramp than most maintain. If Fibre
Channel takes a while to play out, it should be a big positive for
Adaptec. In addition, Adaptec continues to build upon its RAID
investments.
So far, Adaptec's CQ4 is tracking. We are looking for EPS of $0.11 on
revenue of $163MM. The First Call mean is $0.14. We suspect that we
are too conservative on Adaptec and that actual earnings will come in
closer to the First Call mean.
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