Western Digital: Undervalued and Underappreciated

Yesterday we noticed that the charts of MidCap ETFs looked primed for a run, provided the market cooperates. We looked under the hood to see which stocks in the MidCap ETFs might fuel that run.

Based on this, we have highlighted one stock that seems to be undervalued and worthy of your consideration: Western Digital (WDC).

WDC’s top and bottom lines are benefiting from:

• Increasing consumer use of hard drives for the playing, retention, and creation of digital content for personal use in the rapidly growing Consumer Electronics markets.
• Growth of the external hard drive needed for easy storage, portability and backup of music, digital photographs and video.
• Increased use of multiple hard drives in PCs for data backup and expanded storage capacity.
• The need for high performance hard drives in data-intensive applications such as Internet search engines.

We can see room for a higher stock price on many fronts:

We expect upward earnings revisions from Wall Street: For the past 5 years WDC’s has grown a more than a 20% clip. In the past 12 month its growth has accelerated to 45%. For 2009, analysts have WDC pegged for only 7% growth. The Correct Call believes that number is changing as we expect analysts to increase their outlook for 2009.

Currently WDC trades at only .95 times sales, meaning their revenue exceeds the total value of all its shares. If Western Digital were to trade at the industry average of 1.65, WDC’s shares would be worth nearly $49.

WDC’s P/E should expand: At a current P/E of 9.10 and a forward P/E of 7, WDC is trading at a major discount to the industry average of nearly 25 times earnings, yet it is growing faster than almost all its peers. In our view, this makes no sense. Higher growth usually equates to higher P/Es. At a P/E 10, less than half WDC’s 5 year growth rate of 20%+, the stock is 50% higher in 12 months.

We don't believe that WDC’s performance warrants such big discounts.

WDC net profit margin of 13.8% ranks 2nd in the data storage sector and its Return on Equity [ROE] of 39.81% leads the pack. Perhaps the ROE is being aided by the company’s $500 million share buyback program, but not enough to slow down its earnings power. According to a study done by the Investor Business Daily, Most stocks tend to have 15% + ROE before moving higher.

When you add it all up, growing consumer demand, likely earnings revisions, undervalued, strong earnings power, Western Digital looks like The Correct Call .

Disclosure: none

Comments

[User 165567]

Historically, disk drive companies have traded at a low P/E.
Disk drives are commodities and this industry used to be very cyclical and competitive. However, in recent years a lot of consolidation has taken place. It's now dominated by only 2 companies: Western Digital and Seagate.
Therefore, I think it's deserving of a higher P/E.

Disk drives are a commodity that's needed by everybody around the world. China doesn't just need iron and coal; it also needs disk drives!

Western Digital has executed very well. They've gained market share. They are a low cost producer. They've made a good transition to perpendicular recording. Last year they picked up Komag at a low price. Recently they've made a big advance in the smaller drives used in laptops. That's giving them a big boost.

Longer term you have to consider the impact of solid state disk drives. I think conventional disk drives will continue to remain far cheaper and the best solution for storing large files such as HDTV movies.

These are some reasons why I've picked up shares in WDC. My 12 month target price is $40/share. A spoiler could be a global economic recession (which is not occurring yet despite the problems in the US).

[wdcfan]

I bought WDC five yrs ago when it was in second place behind STX and have watched it increase in value over time. This seems to be a well run company, with a plan that they can execute. No dividends, no problem here as the price of the stock has gone up three plus fold. I hold this in my roth acct. How sweet when it hits $40+ and the money comes out tax free.