Western Digital: Seasonality in Share Prices

Sep.22.10 | About: Western Digital (WDC)

Western Digital (NASDAQ:WDC) has been getting a lot of attention from value investors, as well as a steady drumbeat of downgrades and target reductions from the analyst community. Concerns about the future of the hard disk industry, together with excess capacity and a potential price war, have been outweighing a TTM P/E of 4.2, a forward P/E of 7.41, and a strong balance sheet.

However, that could change, because WDC has a definite history of seasonality in its share prices, strong enough to warrant holding through January next year while waiting for prices to recover.

Here are two charts showing the seasonality pattern (click to enlarge images):

Click to enlarge

Click to enlarge

Based on 36 years worth of data, the first chart displays the pattern of relative seasonality against the S&P 500 index. The second displays absolute seasonality for the stock itself. The lower section of the first chart shows month by month whether WDC outperformed the S&P; that section on the second chart shows the percentage of the time that the month involved was profitable.

Holding a full size position with a substantial unrealized loss, I have been asking myself how much longer I should continue to exercise patience. After studying the information shown, it appears that November, December and January have historically been good months to be holding this stock.

Industry revenues also demonstrate a definite seasonal trend.

Western Digital and Seagate (NASDAQ:STX) both end their fiscal years on 6/30. Their 1st fiscal quarter, ending 9/30, features back to school sales together with a first look at inventory build for Christmas. The 2nd quarter, ending 12/31, includes the holiday season, and normally shows the highest revenue and margins. Over the past seven years WDC's 2nd quarter accounted for 26.2% of sales and 29.7% of earnings, disregarding one time charges. Guidance at that point may include insight into corporate IT investment trends. Taken together, these two two quarters can make or break the year. First quarter EPS and guidance will be telling, particularly in view of the inventory overhang for the 4th quarter.

I reviewed the industry capacity and excess inventory situation in early August, concluding at the time that it was manageable. Western Digital, Seagate, and Hitachi (HIT) all expect that the digital storage market will continue to expand, based on statements in their financial reports and/or press releases. The proliferation of digital content is a primary driver. While concerns for excess capacity and competition are understandable, I suspect they are overdone given the published opinion of the larger players.

Hitachi is the third important player in the industry, which has been consolidating. After years of substandard results on its disk operations, Hitachi has worked hard to improve their disk-making operations. From the 20-F:

In the HDD business, we are trying to improve the profitability of Hitachi Global Storage Technologies, Inc., our wholly owned subsidiary. We expect that the HDD market will continue to expand due to a growing need for large volume information storage but also consider that the HDD industry is facing rapid technological changes, such as the development of high capacity HDDs and increasing commoditization of old models. To maintain profitability in such an environment, we believe that it is important to establish efficient development and manufacturing operations. We have therefore been implementing various business reorganization and other cost reduction measures, such as integration of several development and manufacturing facilities for magnetic heads and circular disks, closure of a manufacturing facility, a reduction in the size of our workforce and a reduction in plant and equipment investment. We have also made efforts to introduce new products in a timely manner, by, among other things, strengthening management of product development phases. In addition, we made efforts to strengthen our R&D capability for the purpose of developing and introducing cost-competitive products. As a result of these efforts, our HDD business has recently seen positive operating results.

The newfound competition has generated a lot of concerns within the industry and among analysts. Noting the recent surge in the Japanese yen, it is possible that Hitachi may not be as feisty and competitive as they have been recently.

Taking all of this together, I am looking for WDC share prices to improve on into January next year. At that point, the situation can be reviewed and a longer term decision made whether to continue to hold or to exit the position and look for better opportunities elsewhere.

Disclosure: Author is long WDC, no position in other stocks mentioned