Western Digital Stock: Why Investors Should Accumulate From Here (NASDAQ:WDC)

Summary

WDC's supply constraint issues are temporary.
Stock trades below that of Micron and Seagate on a forward P/E basis.
Strong demand and revenue potential in 2022.
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Data Storage Company Western Digital To Purchase Sandisk For 19 Billion — Justin Sullivan/Getty Images News

When Western Digital (NASDAQ:WDC) tumbled by almost 10% after posting fiscal first-quarter results, it was already stuck in a downtrend. The storage supplier, along with memory chip supplier Micron Technology (MU) underperformed while the Nasdaq index closed at highs.

How did markets know that WDC stock would disappoint investors with a weak outlook?

Supply Constraints

WDC posted non-GAAP EPS of $2.49 and $1.93 on a GAAP EPS basis. Revenue rose by 30.8% to $5.1 billion.

Slide courtesy of WDC Q1/2022 Presentation

In the slide above, Western Digital posted a sequential or quarter-over-quarter drop in revenue. Y/Y comparisons fared better. When the company works through higher logistics costs and supply constraints, revenue will grow above management’s new guidance.

The company’s Q2 forecast for revenue is below the $5.24 billion analyst consensus estimates. It sees revenue in the range of $4.7 billion to $4.9 billion. EPS will fall short of the consensus of $2.63, in the range of $1.95 to $2.25.

The lower guidance and light results are due solely to material shortages and higher logistics costs. When markets realized their folly, WDC stock bounced from the $50.00 low the day after earnings and back to almost $55:

Chart from FinViz

Stronger Balance Sheet

WDC ended Q4F21 with $3.37 billion in cash and cash equivalent. Operating cash flow was $521 million in the quarter. After the cash capital expenditure and debt repayment as shown below, it ended the quarter with cash levels almost unchanged. Most importantly, its debt repayment of $213 million and repayment of a $943 million Term Loan B cut total gross debt outstanding to $7.7 billion.

Slide courtesy of WDC Q1/2022 Presentation

Western Digital’s highest priority is reinvesting in the business, through product innovation. It will also reduce debt, setting a target 1.0x to 3.5x debt-to-EBITDA ratio.

A dividend program and share repurchase would increase shareholder returns but is not the company’s biggest priority. Should the stock be closer to a 52-week low (it is still 48% above that), the company could announce an aggressive stock buy-back. This would lower WDC’s forward P/E below the current forward 5.6 times price-to-earnings.

Investors, already getting a big margin of safety at current levels, would get even more safety and lower risk.

Opportunity

Investors who are skeptical of the Federal Reserve’s view of transitory inflation must question WDC’s transitory effects. Chief Financial Officer Robert Eulau said that the component cost impact is “certainly somewhere in the couple $100 million range and potentially a little worse in the December quarter.” Investors should expect volatility and potentially ongoing underperformance for the next three to six months.

Demand for big data center players also faces component challenges. When resolved after the December quarter, WDC stock could rebound back to this year’s highs. Its stock trades below Micron’s 6.5x forward P/E. Seagate trades at a 9.93x P/E.

WDC shares have the potential to rebound once it and customers resolve the transitory effects. Looking ahead, the storage giant may meet an unmet demand for the smart video market. Demand remains strong. Innovation in the 9-disk platform and OptiNAND are monumental achievements. The firm may offer a “smarter, faster, denser storage drive that could reach an estimated 50TB of capacity this decade.” Those kinds of developments will lift the company's profit margins in the years ahead.

Valuation

Due to the stock’s drop and Seagate remaining steady, Western Digital shares score a “D” grade on momentum:

Data courtesy of SA Premium

WDC has a better growth grade than Seagate. The former has four upcoming events that will raise company awareness to the investor community. It will participate in three technology, media, and telecom conferences on Nov. 30, Dec. 6, and Dec. 7. On Dec. 1, it will participate at the Nasdaq London Conference (source: slide 13).

Risks

Supply chain constraints may persist longer than one or two quarters. The company may sustain margins by cutting costs. Fortunately, it benefits from strong secular demand. It will ramp up production of its BiCS5 on the solid-state drive products in 2022.

CFO Eulau hinted that the December quarter is a bit of an aberration. He said the hard drive business is solid and that supply chain issues are its only constraint.

Component shortages hurt its SSD market. Now that the channel is normalizing, strong seasonality will support strong performance. Furthermore, in the data center segment, customers signaled strong demand for the 20 TB hard disk product.

Your Takeaway

Markets are simultaneously betting on cloud computing and data center markets growing. It is ignoring their need for high-speed data solutions from Western Digital. The company has an expanding addressable market for enterprise SSDs, for example. As components become available, production in 2022 will increase.

WDC stock tested a $50 low and bounced back. The drop may not happen again. As such, investors should consider accumulating the stock at current levels.

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This article was written by

Chris Lau

32.52K Followers

Chris Lau is an individual investor and economist with 30 years of experience covering life science, technology, and dividend-growth income stocks. He has degrees in Microbiology and Economics.

Chris runs the investing group DIY Value Investing where he shares his top stock picks of undervalued stocks with catalysts for upside, dividend-income recommendations with quant and payment calendar tracking, high upside plays, and research requests to help you become a better do-it-yourself investor. Learn more.

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