In the last one year, there has been a considerable appreciation in the price of the shares of Western Digital (NASDAQ:WDC). The price has doubled in a year on account of consistent profits and improved gross margin. Western Digital has been riding on the sale of hard drives that has been picking up in the past decade.
Figure: Movement in the share price of Western Digital in the last one year
Unfortunately, the storage industry is seeing a massive change of late and this could very well depreciate the profitability of the company. This becomes quite an intricate situation for investors interested in the share, as the performance of the company has been extraordinary in the past year but a serious threat from the flash storage industry has the potential to reverse the upswing in the following months. The company has managed to keep pace with the demands of the market by targeting companies specializing in the flash technology and a lot will depend on how the new acquisitions perform in determining the one-year equity market return of Western Digital.
Interpreting The Quarterly Results
Western Digital in the recent quarter reported revenue of $3.8 billion and a net income of $495 million, or $2.05 per share for its first fiscal quarter that ended on September 27, 2013. While revenue was considerably reduced by 5% from a year ago, net income was higher by 4.85% on account of sales of high-margin products. The projections in the core business of Western may not be very promising considering the fact that the company shipped only 62.6 million hard drives compared to the 62.5 million units a year ago.
Figure: Volume (in units) and market share (in %) of Western Digital since Q2'10
The figure above ratifies the fact that the hard drive storage market has been flat since Q4'12. Western Digital has been maintaining consistency in the volume and market share but it cannot rely on high margin sales of the same set of products in this segment if it wants to deliver profits that are in tune with its past. As the sale of personal computers continues to decline, it is inevitable that the company will look to gradually replace its hard disk business with higher-margin storage products and fast-growing cloud storage firms. This has been the recent strategy for the company as it looks for possible targets that are into the flash drive segment. Such a strategy not only diversifies the business of this company but it also enables Western Digital to tap into a high growing, lucrative but competitive market.
What The Latest Acquisitions Have In Store?
While it would be almost impossible to replicate the dream run in the bourse, investors might be wary of the recent acquisitions that Western Digital is banking heavily upon. Five months down the lane, the company has acquired three companies in the flash drive industry. These are Virident, sTec and VeloBit and they have shown tremendous potential in the past. Take the case of Virident that saw its revenue rise by 200% in a year and if the demand for PCIe cards grows in tune with the projected 31% mark, there could be further improvements in the gross margins for Western from this new product line. sTec on the other hand has not been able to perform too well but there could be a complete turnaround for the company as Western Digital forays its baby-steps into the lucrative solid state drives market.
A very common feature for these companies has been their recent upsurge on account of the alteration in computing patterns right away from Personal Computers to laptops and smartphones to tablets. As long as these industries thrive, the recent mergers of Western Digital should not face any sort of problem in delivering the anticipated outcome. These acquisitions may be the sole factor upon which the investors can pin their hope on if they want to see this company replicate yet again their one year ascent on the stock market.
A Year From Now
Western Digital is trading at $70.23 which is very close to its 52-week high. Since the share price has doubled in one year, it is expected that unless the company delivers extraordinary profits, the share price may cool in the coming months. High dependence on the sale of hard disk drives (a market in which it commands around 46%) may also dampen the bottom line considering the fact that the demand in this segment has not been promising. Inorganic growth from its acquisitions is also subject to various risks. Companies like sTec, Inc. have been operating in lucrative segments but have fallen prey to intense competition. Its revenue has been dwindling since 2011 and has already halved in the first quarter this year from a year earlier. While Western Digital is expecting to turn around the fortunes of this company, any wrong strategy may backfire. The following year should see the company in a transition phase as it looks to diversify its product portfolio and reduce its dependency on the disk drives. A lot will depend on the smartphone industry that will fuel the need for flash based technologies that the acquisitions of Western cater to. For investors expecting returns to the tune of what it delivered in a year would be too optimistic an assumption considering the stagnation in the chip industry and the emergence of new players seeking to intensify the competition.
The Wise Move
The next few months could see the stock remain at its current level and an earnings missing could see a steep drop in the share price. While upward movement has limited scope on account of an overheated price, the cooling effect may be more pronounced. Investors still seeking opportunities may want to understand the storage industry and the product class of Western Digital in order to understand the long-term implications of the strategies adopted by the company. Unfortunately, the technology sector is fraught with volatility and the possibility of new products from competitors makes long-term returns a very risky bet.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Analysts at EurEx Consulting. EurEx Consulting is not receiving compensation for it (other than from Seeking Alpha). EurEx Consulting has no business relationship with any company whose stock is mentioned in this article.