Western Digital Still A Strong Buy

| About: Western Digital (WDC)

Western Digital (NYSE:WDC) reported fourth quarter and full year 2012 earnings last Wednesday afternoon that achieved the rare trifecta: surpassed analysts' estimates for EPS and revenue, raised full year 2013 guidance above consensus, and had a "clean" report with bullish management discussions.

Fourth quarter revenue nearly doubled to $4.8 billion (fueled by the Hitachi acquisition), and quarterly EPS was $2.87, both of which exceeded consensus opinions. I declared Western Digital The Best Bargain in Tech in early June, and it has rallied nearly 30%, from the low $30s to nearly $41 in early trading last Thursday. The stock eased back to $40 by the close on Friday, which leaves it just 10 percent below its 52-week high.

After this quick surge in a difficult economy, I can no longer call WDC a bargain, but this tech all-star is well positioned to continue its ascent. I analyzed the full earnings release and conference call, and I wanted to highlight a few key points below that affirm my buy rating on Western Digital.

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WDC Continues To Be A Cash Champion

I was originally attracted to Western Digital due to its strong liquidity, and the company's financial position is continuing to improve. Cash per share only decreased by $0.60 to ~$12.30, and currently accounts for approximately 30% of the company's current market capitalization. I tend to focus less on net cash with WDC because the conversion cycle is a very strong positive at two days.

This slight decline in cash is despite a $300 million investment in PP&E, $600 million debt repayment, and the repurchase of $600 million common shares. Management still has another $1.3 billion available for repurchases that it says will be deployed more "systematically" going forward. Western Digital's commitment to returning funds to shareholders only strengthens my confidence in the company.

Seagate Supply Concerns Are A Non-Issue

Seagate Technology (NASDAQ:STX) warned in early July that it was facing "supplier quality issues" that would negatively impact shipment of hard drives. This news not only impacted Seagate, but also drove Western Digital down nearly five percent.

Seagate and Western Digital have an effective duopoly in the hard disk drive ("HDD") space, so it was only natural to believe that the issues would impact WDC as well. I was initially skeptical about how serious the issues would be, and I am still puzzled about what Seagate was referring to. WDC basically dismissed this issue on the call. In response to a direct question, CEO John F. Coyne stated, "there's always occasional this, that, and the other thing, but nothing significant." Many investors prefer Seagate due to its dividend, but Western Digital is emerging as the better play as it continues to take market share.

The Cloud Is Still King

WDC was the victim of numerous downgrades and bearish reports this past quarter as concerns that consumers were shifting more to solid state drives took priority over the real cloud story. The positive reviews surrounding Apple's (NASDAQ:AAPL) new MacBook Air and the iPad will certainly accelerate the adoption rate of solid state drives, but the economics of hybrid hard drives (HDD) still necessitates their use for cloud storage. Out of the 71 million HDD shipped in the quarter, 54 million were to the client space, indicating that WDC will continue to thrive in the cloud. As I emphasized in my last WDC article, the success of Apple and other companies that help to generate content (pictures, videos, etc.) will benefit Western Digital in the long-term, as it will spur increased demand for cloud storage.

Future OPEX Benefits On The Horizon

Western Digital completed its acquisition of Hitachi in 2011. Due to regulatory requirements, however, it still must operate Hitachi as separate subsidiary for a minimum of two years. As a result, the typical operating expense synergies associated with such a large acquisition will not materialize in the near-term. Furthermore, the company had approximately $40 million of acquisition related charges this quarter that are unlikely to recur going forward. The acquisition is already yielding healthy benefits to the top line, and further cost savings are likely to emerge in future years.

How To Play It

Analysts were quick to revise their price targets after the earnings release, with five brokerages updating their targets. For example, Citi increased its price target from $40 to $49, while Barclays revised upward from $32 to $38, which is currently below the market price. I am still bullish on Western Digital's future; however, I took advantage of the pop last Thursday to sell WDC Aug 3 2012 (Weekly) $41 Calls, which I hope will expire worthless.

Seagate reported earnings today that failed to meet revenue or earnings targets. The stock had a cautious outlook, and is currently down approximately eight percent after-hours. This news has knocked Western Digital down almost three percent, but I believe Seagate suffers from many unique issues. Long term, I see Western Digital testing and surpassing its 52-week high of $44. I wish you congratulations if you followed my advice on WDC before earnings, but this success story is far from over. With a forward P/E of 5.2, this is still a very attractive investment that can climb higher.

Disclosure: I am long AAPL, WDC, and short WDC Aug 3 (Weekly) 41 Calls.

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