Western Digital Looks Strong in the Face of PC Demise


As earnings season drags on into its final stretch, technology stocks have been the laggards. For hard drive manufacturers, the issue is the inevitable decline of the PC. The two leaders in the space, Western Digital and Seagate Technology , are guilty by association whenever the other mentions future declining demand, but there is more to look at than just PC hard drive shipments. Western Digital recently posted strong earnings, but the stock didn't react. How should investors factor in the PC apocalypse for the future of Western Digital? Let's take a look at the company's second quarter earnings for hints.

An impressive run
The end of 2012 was kind to Western Digital, which swung high and low throughout the year based on analyst and investor fears regarding the company's ability to adapt in a post-PC world. But while the pundits were at work, the company continued to grow its sales and generate free cash flow. The stock sailed into 2013 looking strong and has witnessed a three-month jump of nearly 35%.

The second quarter of fiscal 2013, ended in December, confirms the theories behind the rise in its stock price.

Quarter in review
For the second quarter, Western Digital was able to bring in $3.8 billion in revenue. This handily surpassed the analysts' expectations of $3.68 billion. Gross margins for the quarter were at 27.7% -- a tad bit higher than rival Seagate's 27 % gross margin, which was down a few points from the prior year's quarter. Net income sailed higher from the previous year to $335 million on a GAAP basis, and $513 million for non-GAAP. This translates to $1.36 per share and $2.09 per share, respectively. The adjusted EPS number (non-GAAP) surpassed analyst expectations of $1.82 per share by a long shot.

Western Digital brought in $526 million in free cash flow in the December quarter. This helped bring the total cash and equivalents for the company to an impressive $3.8 billion and net cash of $1.7 billion. Not always the case in technology companies, both Western Digital and Seagate's biggest appeal may be in their ability to generate tons and tons of cash for distribution to shareholders. Western Digital initiated its first dividend back in October and continued it in the December quarter.

All in all, things look strong for Western Digital's second quarter. Certainly better than competitor Seagate, which also saw a substantial rise in revenue, but was unable to translate that to bottom-line growth based on rising costs and softening margins. Just a year ago, the situation was reversed as Western Digital greatly suffered from the flooding in Thailand that nearly ceased production for the hard drive manufacturer.

Of course, the stock didn't react the way it should have, as analysts and investors continue to be seemingly surprised that PC demand will decline in future quarters.

Can Western Digital pick up the game in other areas to compensate?

WD enterprise
Though typically ruled by Seagate, Western Digital has made substantial gains in its enterprise segment, with shipments rising 10 % over the year-ago quarter. The enterprise business is a great one for these companies, as they typically demand higher prices (i.e., higher margins) and are not influenced by the PC issue.

This is just one example of how both Western Digital and Seagate can continue to grow their businesses in new areas underutilized in the past. Sure, laptops and desktops are going the way of the dinosaur, but with that extinction comes a new breed -- more phones, more tablets, more clouds. All of these relatively young trends require storage solutions, whether on the ground or in the sky. The leading storage providers, though not originally conceived to address these concerns, are in prime position to shift gears into the new wave.

WD vs. ST
On a short-term basis, I am more impressed with Western Digital's performance and its ability to keep costs low in the tepid environment. Looking down the road, though, I am still a loyal Seagate-ist. For one, I believe in CEO Steve Luczo. Luczo has very efficiently managed the shift in strategy for Seagate and done so without igniting too much backlash. He is cautious, yet optimistic. Or as every CEO likes to say in conference calls, cautiously optimistic.

Both companies trade around six times forward earnings, and I believe are undervalued given their long-term prospects. But with Seagate's impressive dividend and management team, Western Digital takes a second seat in my stock wish list.

More Foolish analysis
While Seagate Technology pays a significant and growing dividend and seems able to generate the cash flow to support it, a global slowdown in demand for digital memory storage has begun to put pressure on margins. Is Seagate worthy of your investment consideration? The Motley Fool answers this question and more in our most in-depth Seagate research available for smart investors like you. Thousands have already claimed their own premium ticker coverage, and you can gain instant access to your own by clicking here now.

The article Western Digital Looks Strong in the Face of PC Demise originally appeared on Fool.com.

Fool contributor Michael B. Lewis has no position in any stocks mentioned. The Motley Fool owns shares of Western Digital.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.