Investors in Western Digital (WDC) saw a boost on Wednesday after analysts at Morgan Stanley issued a bullish research report on the firm.
While I agree that Western Digital is attractive at current valuation multiples, given its solid strategy and strong historical performance, I would be a bit more cautious. The solid momentum so far this year, combined with the cyclical nature of the industry make a correction always among the possibilities.
As such I continue to be optimistic about the long term prospects, yet I would be more cautious in the short to medium term.
Morgan Stanley Continues To Be Positive
Analyst Katy Huberty at Morgan Stanley (MS) upgraded her rating on Western Digital from "Equal-Weight" to "Overweight". At the same time, Huberty reiterated her $85 price target, suggesting some 12-13% upside from Tuesday's levels.
Huberty notes that cloud computing adoption accelerates faster than expected. As a result of these developments, Western Digital offers a better risk/reward ratio at current levels than previously anticipated. Given the very strong momentum so far this year, it seems to me that the market already largely priced in these developments.
Western Digital opened its books for the first quarter of the fiscal 2014 at the end of October. The company ended the quarter with $4.87 billion in cash and equivalents. Total debt stood at $2.17 billion, resulting in a net cash position of $2.7 billion.
First quarter revenues came in at $3.80 billion, down 5.7% on the year before. Net earnings came in at $495 million, down 4.6% compared to the same period in the fiscal 2013. Note that last year's first quarter was very strong on the back of the floodings in Thailand.
Trading around $77.50 per share, the market values Western Digital at $18.3 billion. This values operating assets of the firm at $15.6 billion, equivalent to 1.0 times annual revenues for the fiscal 2013 and 16 times annual earnings. Note that hefty charges in the fourth quarter resulted in depressed earnings. Excluding these charges, the company trades around 10 times annual earnings.
Western Digital currently pays a quarterly dividend of $0.30 per share, for an annual dividend yield of 1.5%.
Some Historical Perspective
Long-term investors in Western Digital have seen great returns. Shares have steadily risen from levels around $7 per share in 2004 to highs of $40 in 2008. Shares fell back to lows of $10 later that year but quickly recovered to levels around $40 per share.
After witnessing very solid returns so far this year, with shares trading up over 80% year to date, shares are currently trading at all time highs just below $80 per share.
Between the fiscal year of 2010 and 2013, Western Digital has increased its annual revenues by a cumulative 55% to $15.4 billion. Earnings have been volatile and came in between $700 million and $1.6 billion in recent years.
Western Digital has done very well in recent times, despite the decline in the personal computer market. While hard disk drive demand is down, demand for hard drive by cloud storage firms continues to be very solid.
As a result, the total addressable market in terms of units has declined in recent months, yet Western Digital has boosted its market share from 30% to 45% since 2010. While technology firms are typically plagued by lower average selling prices going forwards, the demand for high end devices resulted in average selling prices of $58 over the past quarter, thereby being relatively stable.
Back in September, I last took a look at the prospects for the firm. I concluded that long term appeal remains after the company announced another strategic acquisition. At the time, Western Digital bought Virident Systems for $685 million in cash, boosting its presence in the SSD market. Note that this marked the third acquisition of Western Digital in just three months time.
The deal shows the company's commitment to the solid state drive market, as well as its intentions to bolster growth and secure its competitive position. The strong financial position, strong strategic actions and appealing valuation, made me optimistic at the time. Ever since, shares have risen another 20% to current levels approaching $78 per share.
While the current circumstances look very appealing, I would hold off on initiating a long position at current levels. Given the solid momentum so far this year and the cyclical nature of the industry, I would remain a little bit more cautious than analysts at Morgan Stanley.