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Summary

  • The estimated intrinsic value is $93.80 per share.
  • WDC has a strong product pipeline.
  • The technicals remain long-term bullish.

Shares of Western Digital Corporation (NASDAQ:WDC), the electronic data storage device manufacturer, declined moderately following fiscal second quarter results that beat expectations but third-quarter guidance that disappointed investors.

Despite the relatively weak guidance, WDC remains well positioned in the electronic data storage industry following substantial investments in SSDs. Also, the firm's product pipeline is amongst the best in the industry with the My Cloud EX2, Touro S mobile, Ultrastar C15K600, Ultrastar He6, and WD Black. But the firm lacks an embedded solution for mobile devices. That said, WDC is expected to gain share in enterprise SSD and maintain a substantial share of the HDD market.

Considered in aggregate, the outlook for WDC is bullish and there is substantial confidence in the near $94 per share intrinsic value estimate.

Recent Developments

  1. WDC released the My Cloud EX2 and EX4, a high-performance two-bay network attached storage system, which is an external hard drive designed with mobile users in mind.
  2. HGST is expanding its line of external storage and backup solutions with its new line of Touro S mobile external hard drives.
  3. WDC is shipping a new line of high-performance, high-capacity, 2.5-inch small form factor 15k RPM enterprise-class HDDs, which are known as the Ultrastar C15K600.
  4. The board of directors declared a cash dividend of $0.30 per share of common stock.
  5. WDC is able to reapply to Chinese officials about further integrating HGST.

Business Summary

Western Digital Corp. is a global provider of products and services that empower people to create, manage, experience and preserve digital content. WDC designs and manufactures storage devices, networking equipment, and home entertainment products.

(click to enlarge)

According to data from IDC and WDC, Exabytes are expected to grow at a CAGR of 34% through 2020. Consequently, WDC's industry has a tailwind with WDC well positioned in personal storage, client, and enterprise systems.

For fiscal year ending (in million of dollars expect per share data):

2011-06

2012-06

2013-06

2014-06E

2015-06E

Revenue

$9,526

$12,478

$15,351

$15,200

$15,960

Gross profit

$1,791

$3,638

$4,363

$4,408

$4,788

Operating income

$781

$1,771

$1,266

$2,014

$2,234

Net income

$726

$1,612

$980

$1,520

$1,596

Basic EPS

$3.14

$6.69

$4.07

$6.41

$6.79

Diluted EPS

$3.09

$6.58

$3.98

$6.26

$6.62

For 2014, I expect revenue to be roughly flat as the PC market continues to adversely impact performance. The improvement in operating income and net income during the year emanates from a $681M charge during fiscal 2013. For fiscal 2015, I expect revenue to increase 5% as conditions in the PC market improve on enhanced PC product offerings and increased sales of SSDs. Also, WDC's and HGST's products pipelines are amongst the best in the industry, which should positively impact financial performance.

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This graphic shows the SDD market growing at an 18.75% CAGR through 2017. That will obviously have a positive impact on WDC's financial performance. Most of the impact will be in fiscal 2016-2018.

For the year ending:

2011-06

2012-06

2013-06

2014-06E

2015-06E

Cash ratio

1.61

0.80

1.08

--

--

Current ratio

2.53

1.77

1.91

--

--

Ending financial leverage

1.48

1.85

1.78

1.78

1.76

Debt-to-capital

5%

22%

20%

--

--

Management decreased the level of cash from excessive to ample, in my opinion. Also, the leadership of the firm decided to increase the use of financial leverage to about 20% of total capital. Management could increase financial leverage, if necessary.

For the year ending (in millions of dollars):

2011-06

2012-06

2013-06

2014-06E

2015-06E

CFO

$1,655

$3,067

$3,119

$3,040

$3,591

Capex

$778

$717

$952

$912

$958

FCFF

$886

$2,374

$2,218

$2,179

$2,684

FCFE

$771

$3,632

$1,937

$2,128

$2,633

Share repurchases

$50

$604

$842

$800

$1,000

Dividend paid

$181

$250

$400

Cash flow from operating activities is forecasted to be roughly flat this year, for the third consecutive year. But CFO is expected to increase to almost $3.6B in fiscal 2015. Free cash flow is expected to increase substantially in fiscal 2015. Also, cash returned to shareholders could exceed $1B this year before reaching $1.4B in fiscal 2015.

WDC started investing in SDD in 2008 and those investments should start to pay material dividends in the coming years. The company has made several key acquisitions in the enterprise SDD space, which gives WDC a leg up on some of its competitors. Also, if Chinese regulators clear the completion of the HGST deal, investors will benefit from the synergies. The aforementioned is in combination with what I consider to be one of the best product pipelines in the industry. The outlook for WDC is favorable throughout the rest of fiscal 2014 and through 2015.

Portfolio & Valuation

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WDC is in a bear market of intermediate degree and a bull market of primary degree. The share price is expected to continue to consolidate through the rest of the first quarter and through at least part of the second quarter.

Monthly expected return

Quarterly expected return

Monthly standard deviation of returns

3%

8.81%

11.9%

Intrinsic value estimates

Base case forward valuations

Optimistic

$109.50

P/E: 15

Base case

$93.80

P/BV: 2.64

Pessimistic

$78.20

P/S: 1.5

P/CF: 7.5

A fundamentals-based capitalized cash flows model was used to derive the intrinsic value of WDC. Based on the base case inputs, the intrinsic value is 9.5% above the current share price. The model is based on fiscal 2014 inputs. At the base case intrinsic value, WDC would be trading at 15 times fiscal-2014 earnings.

Source: Western Digital Corporation: An Undervalued Rock Star Of Electronic Storage