Western Digital: It's Rare To See A Large-Cap This Undervalued

Summary

• It's rare to see a large-cap company, such as Western Digital to be this undervalued, especially in the tech industry.
• The company has strong future growth prospects, a great balance sheet, and strong financials, especially when compared to competitors.
• Western Digital didn't rally following a recent earnings report. Both revenue and EPS beat, and guidance was strong.
• Western Digital is also a surprising income play, with a yield of over 2%.

Western Digital (NASDAQ:WDC) a large-cap company that manufactures digital storage devices and is currently trading at up to a 33% discount to a fair value. Recent Q3 earnings did little to boost share value, even though they surprised investors with higher-than-expected revenue and EPS, as well as strong guidance for the coming period. For the long term, the data storage industry is poised for strong growth, driven by the exponentially growing demand for data storage. Yet, share prices are in a dip, down about a quarter from their all-time highs of about $106, which they reached in January. All signs point towards a great company with a currently undervalued share price, and strong future growth. The current dip is only a greater buying opportunity for investors to make an entry into this undervalued large-cap.

Valuation

WDC 50-Day Exponential Moving Average data by YCharts

Despite volatility, WDC has been on a long-term upwards trend for the past few years, with the 200-Day exponential moving average jumping 226.2% in the past 10 years.

Currently, $78 a share is well out of the range of these averages and soon to hit a bottom, if not there already.

The company is very profitable. For the past 10 years, we've seen steady revenue growth of 136%.

WDC Revenue (Annual) data by YCharts

And, though not pictured on this graph, WDC posted a pretty high EPS of $3.63 in the most recent quarter, which beat estimates by $0.34.

WDC Gross Profit Margin (TTM) data by YCharts

Driving the impressive revenue growth is the company's gross profit margin, which is steadily rising. In the most recent earnings report, WDC said that non-GAAP gross margin grew to 43% (not pictured on chart).

WDC Total Expenses (TTM) data by YCharts

And recently (within the year), WDC has managed to keep expenses flat while growing annual revenue.

When compared to its main competitor, Seagate (STX), Western Digital looks even better.

WDC Cash and Equivalents (Quarterly) data by YCharts

Western Digital has about $6.3 billion in cash (reported in most recent earnings, not pictured on YCharts), compared to Seagate's $2.55 billion.

STX PE Ratio (Forward) data by YCharts

This P/E ratio of 5.4x is extremely rare to see in a tech stock - usually, they are above 10x (like Seagate), and the industry average for data storage manufacturing companies is 15.52x.

STX Price to Book Value data by YCharts

Price to Book value is the same story. As Seagate's value rockets upwards, Western Digital remains at 2x.

(Computer Storage Devices - Top Stocks - Source.)

Also, in the industry, Western Digital is the largest player. Again, compare P/E, P/S, and P/B ratio values. Western Digital comes in last when comparing these values to the other two large companies on the list, Seagate and NetApp (NTAP), and the company is largely undervalued.

For an investor, this industry is great. Demand for some form of digital storage will always continue to grow in this data-hungry world, and the industry only has three major players. Because the majority of business in this industry comes from big enterprises, the buyers aren't likely to switch to a smaller, or newer player, and there is little room for new players.

(Market Drivers - Source: Investor Presentation)

However, this industry is traditionally cyclical, pushing some investors away from semis or digital memory. But recent earnings from Lam (LRCX), Samsung (OTCPK:SSNLF), and WDC all post good guidance for increasing demand in the future, indicating that we won't see a downturn for at least a year.

Let's take a look at a F.A.S.T. graph, one of my favorite valuation models out there.

This analysis tool shows us multiple things. Firstly, the orange valuation line - this software calculates a fair long-term valuation based on multiple factors and charts it. The black line is the actual price of Western Digital - if it goes over the valuation line, that means that the stock is overvalued. If it goes under, then the stock is undervalued. Right now, the fair value line is picking up, but the real price is moving far underneath it, and it always has been - just another indicator that the stock is currently on sale right now.

Also, adding to investor value is the slowly growing dividend and share buyback program.

This chart is a representation of WDC's dividend. The last time they grew their dividend was in March 2015, and the dividend currently has a yield of 2.51%. That's a strong yield for a tech company and could be an income player. However, we feel that there will be limited upcoming dividend growth because the payout ratio exceeds 100% (116%), and while the company has a large cash reserve, it is better used to chip away at debt.

This quarter, the company executed $155 million of the $500 million share buyback that had been announced. This should help with long-term growth.

Now, we've been referring to the recent Q3 report, but let's look at it more specifically. They post great growth and guidance, yet see no market rally.

(8% revenue growth. Source: Investor Presentation)

(Results. Source: Investor Presentation)

Growth in every aspect is impressive. A 52% YoY increase in EPS, and a 30% increase in operating income is no small feat.

Some investors were getting worried that flash storage (which WDC is involved in) would steal Western Digital's legacy PC hard drive business, but that's not the case. In fact, revenue in this segment went up, said Stephen Milligan, CEO in the Q3 earnings call:

Our operating cash flow reflected solid execution supported by healthy demand for our products, particularly high capacity enterprise drives, which achieved record quarterly revenue.

This is great, showing healthy demand that will push the company to more growth.

When discussing driving factors of this quarter's growth, Mr. Milligan said this:

Macroeconomic conditions remained supportive in the quarter with Cloud Computing and Mobility serving as primary demand drivers. The positive third quarter dynamics included continued strong demand for our NAND flash products. Our results in the March quarter demonstrate the power and agility of our platform and a sustained focus on operational execution by our global team.

Guidance was equally as impressive - management expects $5.0 billion to $5.1 billion in revenues, which is above the Wall Street consensus of $5.07 billion, as well as an EPS of $3.40 to $3.50, higher than the street consensus of $3.29. Mark Long, CFO, discussed this in the same call:

For calendar 2018, we continue to expect revenue growth at the high end of our long-term model. Previously, we had indicated that our quarterly non-GAAP gross margin for calendar 2018 would be above the high end of our long-term model of 33% to 38%. We now expect that non-GAAP gross margin will be at least 40% for each of the remaining calendar quarters of 2018.

Yet, we didn't see an earnings spike, and five days later, shares are down 10%.

Why?

So, the big question is why. Why is Western Digital receiving no love from investors?

First, refer back to the F.A.S.T. graph. You'll see that for the 10-year period, the actual value of WDC has never crossed over the fair value line, meaning that share value has always been undervalued.

We feel that some investors feel that a short-term spending spree by large data companies (fueled partially by crypto fever) is over, and the market is going to retract. We've seen all tech stocks taking a beating in the past few months, and these companies are simply not currently in favor, resulting in volatility.

The company is also pretty leveraged, and somewhat dependent on cash flow, which may cause some investors to be wary.

Conclusion

Despite current weakness mainly due to market conditions, numbers don't lie. WDC is a great company with solid growth and business, that is vastly undervalued. We don't usually see this value in large-caps, especially tech stocks. Following a great Q3 earnings call, shares are actually down 10%, but this dip only presents investors with a buying opportunity. Wappinger Capital Research feel that there is as much as 33% upside within a 12-month period and sets a price target of $114.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WDC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.