Why Western Digital Stock Is A Good Investment Opportunity

Aug.21.14 | About: Western Digital (WDC)

Summary

Western Digital will continue to benefit from a robust demand in gaming and an increase in demand for PCs.

WDC's stock has plenty of room to move up.

Western Digital has compelling valuation metrics; its Enterprise Value-to-EBITDA ratio is very low at 6.57.

Western Digital (NASDAQ:WDC) stock has surged strongly since the start of 2013. In fact, its relative strength index (RSI) technical indicator is indicating overbought conditions. Since the beginning of 2013, WDC's stock has gained an astounding 137%. Nevertheless, in my opinion, WDC's stock still has plenty of room to move up. I believe that Western Digital will continue to benefit from a robust demand in gaming and an increase demand for PCs. In fact, the company anticipates better demand in the second half of calendar 2014. Western Digital has very good valuation metrics and solid earnings growth prospects; its Enterprise Value-to-EBITDA ratio is very low at 6.57. In addition, Western Digital is generating strong free cash flows and returns value to its shareholders by stock buyback and increasing dividend payments.

The Company

Western Digital Corp. engages in the design, development, manufacture and sale of memory devices, most notably hard disk drives, for the PC, server, and consumer device markets. The company was founded in 1970 and is headquartered in Irvine, California.

Valuation Metrics

The table below presents the valuation metrics of WDC, the data were taken from Yahoo Finance and finviz.com.

Western Digital's valuation metrics are very good; the trailing P/E is at 15.10, the forward P/E is very low at 11.39, and the Enterprise Value/EBITDA ratio is also very low at 6.57.

According to James P. O'Shaughnessy, the Enterprise Value/EBITDA ratio is the best-performing single value factor. In his impressive book "What Works on Wall Street", Mr. O'Shaughnessy demonstrates that 46 years back-testing, from 1963 to 2009, have shown that companies with the lowest EV/ EBITDA ratio have given the best return. Mr. O'Shaughnessy explains that EV/ EBITDA is a better way to assess value-that is, how cheap or expensive it is-than looking at the P/E ratio alone. The EV/ EBITDA is neutral to a company's capital structure and capital expenditures. Stocks that have very high debt levels often have low P/E ratios, but this does not necessarily mean that they are cheap in relation to other securities.

Latest Quarter Results

On July 30, Western Digital reported its fourth-quarter and fiscal year 2014 financial results, which beat EPS expectations by $0.11 (6.30%), and beat Street's estimates on revenues.

For the fourth quarter, the company reported revenue of $3.7 billion and net income of $317 million, or $1.32 per share. On a non-GAAP basis, net income was $445 million or $1.85 per share. In the year-ago quarter, the company reported revenue of $3.7 billion, a net loss of $265 million, or $1.12 per share. Non-GAAP net income in the year-ago quarter was $477 million, or $1.96 per share.

In the report, Steve Milligan, president and chief executive officer said:

We achieved strong financial results in the June quarter, with better-than-anticipated revenue, healthy gross margin performance and continued strong cash flow generation. We did so by addressing continued robust demand in gaming and stronger-than-expected demand in notebook PCs, demonstrating our flexibility and capability in high-volume businesses. We also saw strength in our performance enterprise business.

Dividend and Share Repurchase

Western Digital has been paying uninterrupted dividends since 2012. The forward annual dividend yield is at 1.59%, and the payout ratio is only 16%.

WDC Dividend Chart

WDC Dividend data by YCharts

Since the company generates lots of cash (ttm price-to-free-cash-flow is only 12.29), and the payout ratio is very low, there is a good chance that the company will continue to raise its dividend payment.

The company generated $713 million in cash from operations during the June quarter, ending with total cash and cash equivalents of $4.8 billion. During the June quarter, the company utilized $272 million to repurchase 3.2 million shares of common stock. The company generated $2.8 billion in cash from operations during the fiscal year and it utilized $1.1 billion for dividends and share repurchases.

Competitors and Group Comparison

A comparison of key fundamental data between Western Digital and its main competitors is shown in the table below.

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Western Digital has the lowest EV/EBITDA ratio among the stocks in the group, and the second highest dividend yield. However, its PEG ratio is higher than that of STX and EMC.

Western Digital's Efficiency and Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median, as shown in the table below.

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Source: Portfolio123

Ranking

According to Portfolio123's "Momentum Value" powerful ranking system, WDC's stock is ranked third among all S&P 500 tech stocks, only Hewlett-Packard (NYSE:HPQ) and Seagate (NASDAQ:STX) are ranked higher (see my article about STX). The "Momentum Value" ranking system is quite complex, and it is taking into account many factors like; average yield, price to book value, trailing P/E, price to sales, return on equity, sales growth and relative strength, as shown in the Portfolio123's chart below.

Back-testing over fifteen years has proved that this ranking system is very useful.

Technical Analysis

The charts below give some technical analysis information.

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Chart: finviz.com

The WDC stock price is 0.19% above its 20-day simple moving average, 4.32% above its 50-day simple moving average, and 16.21% above its 200-day simple moving average. That indicate a strong uptrend.

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Chart: TradeStation Group, Inc.

The weekly MACD histogram, a particularly valuable indicator by technicians, is at 0.46 and descending, which is a bearish signal (a rising MACD histogram that is crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 71.14, which indicate overbought conditions.

Analyst Opinion

Many analysts are covering the stock, and most of them recommend it. Among the twenty-six analysts, seven rate it as a Strong Buy, thirteen rate it as a Buy, five rate it as a Hold, and one analyst rates it as an Underperform.

TipRanks is a website that ranks experts (analysts and bloggers) according to their performance. According to TipRanks, among the analysts covering WDC stock there are ten analysts who have the four or five star rating, nine of them recommend the stock, and one top analyst rates it as a Hold.

On July 31, RBC Capital Markets analyst Amit Daryanani maintained his outperform rating on Western Digital stock and raised his price target to 105 from 100. According to Mr. Daryanani, Western Digital is expected to see a rebound in enterprise sales and continued improvement in the PC market and synergies as past acquisitions are integrated into the business.

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Source: TipRanks

Major Developments

According to Western Digital, it has seen continued robust demand in gaming and stronger-than-expected demand in notebook PCs. CEO Steve Milligan stated that WDC anticipates better demand in the second half of calendar 2014. The better outlook reflects the improving outlook in PCs as well as anticipated growth in the capacity enterprise space. According to the company, based on its unit shipments, WDC's fiscal 4Q14 hard disk drive (HDD) market share was 45.7%, compared with 45.1% a year earlier and 44.1% in fiscal 3Q14.

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Source: Fourth Quarter Fiscal 2014 Quarterly Fact Sheet

In my opinion, Western Digital will benefit from an increase demand for PCs, that trend was also affirmed by industry research firm Gartner. In a press release from July 09, Gartner said that after eight quarters of declining shipments, worldwide PC shipments experienced flat growth in the second quarter of 2014. According to preliminary results by Gartner, worldwide PC shipments totaled 75.8 million units in the second quarter of 2014, a 0.1% increase from the second quarter of 2013.

Western Digital has been able to show an earnings per share surprise in each one of the last four quarters, as shown in the table below.

Data: Yahoo Finance - Analyst Estimates

In my opinion, the fact that the company succeeds to beat analyst expectations quarter after quarter demonstrates the strength of its business, and there is a good chance that Western Digital will continue to surprise by reporting better than estimate results also in the future.

WDC's stock has significantly outperformed the market this year and in 2013. Since the start of the year, WDC's stock has gained 20.2% while the S&P 500 index has risen 6.7%, and the Nasdaq Composite Index has increased 7.9%. Moreover, since the beginning of 2013 WDC's stock has recorded an astounding gain of 137.3%, while the S&P 500 index has increased 38.3%, and the Nasdaq Composite Index has risen 49.3%. Nevertheless, considering its compelling valuation metrics and solid earnings growth prospects, the stock, in my opinion, is not expensive.

Conclusion

I believe that Western Digital will continue to benefit from a robust demand in gaming and an increase demand for PCs. In fact, the company anticipates better demand in the second half of calendar 2014. Western Digital has very good valuation metrics and solid earnings growth prospects; its Enterprise Value-to-EBITDA ratio is very low at 6.57. Moreover, WDC's stock is ranked third among all S&P 500 tech stocks, according to Portfolio123's "Momentum Value" powerful ranking system. In addition, Western Digital is generating strong free cash flows and returns value to its shareholders by stock buyback and increasing dividend payments. The company generated $2.8 billion in cash from operations during the fiscal year and it utilized $1.1 billion for dividends and share repurchases.

All these factors bring me to the conclusion that WDC stock is a smart long-term investment.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.