Yahoo Finance The One Word That Tanked Western Digital Stock
The storage market has enjoyed a tremendous run over the past few years. With demand for high-capacity storage exploding in order to feed the trend in big data processing, enterprises and hyperscale cloud computing vendors have been buying memory of all types hand-over-fist.
Western Digital (NASDAQ: WDC) makes non-volatile memory (which retains data even when power is turned off), both on hard disk drives, as well as newer NAND flash memory technology (by way of its 2016 Sandisk acquisition). Hard disks are much cheaper, but NAND is more durable and faster, thus replacing HDDs in many applications.
Western Digital's fiscal third quarter earnings report seemed flawless on the surface: Revenue of $5 billion beat analyst expectations, and non-GAAP earnings per share of $3.63 also outperformed. Not only that, but guidance for next quarter's earnings per share was very strong.
And yet, Western shares fell nearly 8% post release, and the stock now trades at less than 6x forward earnings estimates. What gives?
Can Western Digital manage an ASP decline? Image source: Getty Images.
"Normalizing"
The word that sent Western Digital shares down is: "normalizing".
In describing the price forecast for storage this year, CEO Steven Milligan said average selling prices, or ASPs, would continue to decline, at least in the coming quarter:
... obviously we were an allocated environment with rising ASPs and that sort of thing. And when we're looking at a normalizing environment, that means that we're going to kind of more normal, more consistent ASP declines like we've seen historically in a controlled environment. So, you're basically seeing the margin percentage drift down a bit, but in a very measured way. And so we're seeing a bit of that. We're not alarmed by it. It's still a great environment for us. And so that's really what we mean by normalizing.
The memory market has traditionally been very cyclical in the past, with large swings in pricing impacting profitability for the major players, Western Digital included.
Data by YCharts.
As you can see, profits spiked in 2017 after a downturn in 2016 as major cloud computing players spent heavily, building out data centers across the globe. Since demand has remained strong, however, all of the major HDD and NAND players have increased capacity, which has, it appears, caught up with demand. In addition to WDC management, the website DRAMexchange also forecasts continuing price declines in 2018, by as much as 10% to 15% in the next quarter.
But all is not lost
Clearly there's fear in owning memory companies as ASPs are rolling over, but that doesn't mean Western Digital investors should panic. Lower-priced NAND should stimulate demand in the marketplace, leading to increased unit shipments. In addition, Western Digital's migration from 64-layer NAND to 96-layer NAND (or a denser amount of bits in the same amount of space) should lower its cost per bit, which should help margins remain more or less intact. Management claims each "node transition" lowers the company's cost-per-bit by 15% to 25%.
That should allow Western Digital's gross profit to remain stable, while increased bits shipped will largely offset price declines. That's why management still forecasts revenue growth coming in at the higher end of the company's long-term 4% to 8% target for 2018, and for gross margins to remain above 40% each quarter this year. While that's below last quarter's stellar 43.4%, those margins are still above the company's long-term guided range between 33% and 38%.
A cheap stock
As Warren Buffett once said, "be greedy when others are fearful". And clearly, there's fear in Western Digital's stock right now. While flash and HDD prices may have peaked, the pace of declines are not known.
Still, no one likes to hold a stock with declining earnings, but you aren't exactly paying a premium for Western Digital at roughly six times forward earnings, as it appears the market is pricing in either a rapid or longer-term decline in storage pricing.
But should earnings and free cash flows remain relatively stable, Western Digital will continue to pay down its $11 billion debt load (a result of the SanDisk acquisition), which will further lower risk for the company. In addition, a well-covered 2.3% dividend pays you to wait for the outcome.
Investing in storage is not sexy, but for value investors, Western Digital is worth a look. The current price below $80 per share is also below every single analyst's price target, according to Yahoo Finance. For those reasons, Western Digital belongs on your radar after the post-earnings weakness.
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Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of some of the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
