Will Western Digital Fill the Void?
Before mankind wrote it down, information was passed along orally, but the invention of paper and pen solved this dilemma. Only recently have we begun to save and store information electronically, and we can only assume this will be the trend of the future.
Western Digital is one of a few companies that satisfy the world's insatiable appetite for electronic storage solutions through the use of hard disk drives (HDDs), or hybrid drives that combine a HDD with a solid-state drive, or SSD. Data storage solutions are evolving from the older HDD technology to solid-state, yet there is still great demand for HDD and hybrid drives, since HDDs are still a cheaper solution. HDDs are getting small, thinner, and lighter while at the same time with ever-larger capacities and speed. While HDDs still utilize a spinning, magnetized disk for data recording, the newer generation of SSD drives is an extension of a data chip.
Along with its rivals, Western continues to manufacturer the older HDDs along with the newer hybrid drives and SSDs. The competition in the SSD sector is more robust, with heavyweights such as Intel and SanDisk as well as start-ups such as Fusion-io and Violin Memory in the ring.
Some experts believe that SSDs may force the older HDD technology out of business. SSDs use less power, are considered more reliable, and can transfer data faster than HDDs. However, HDDs still have the advantage of storing larger amounts of data, and they are cheaper in relation to the amount of data they can store. SSDs have only recently cracked the 1 terabyte barrier for storage capacity. A disadvantage of SSDs is that they lose their ability to store data efficiently over time. This won't happen with HDDs, but their mechanical parts can fail.
Information technology is expanding at the speed of light, and now we are subjected to new terminology like "cloud computing." Western's management noted in its recent quarter report that the company has positioned itself to take advantage of "a long-term secular growth trend -- the ongoing expansion in digital data due to its leadership in all three data storage solutions. A review of its financials could reward astute Fools.
Western's revenue for the quarter ending June 28 rose 23% average year over year to $15.35 billion, but last quarter's revenue was down 22% from the same quarter last year due to a revenue spike in the 2012 quarter. This was likely due to an acquisition of Hitachi's storage business, so the drop was temporary. Over the last four quarters, year-over-year revenue growth has averaged 36%. According to Western's most recent quarterly report, over the last 10 years, the company has achieved consistent profitable growth, with revenues up 19% and earnings per share up 16% on a compounded annual growth rate basis.
Western gets 26% of its revenue from the Americas, 20% from Europe, the Middle East, and Africa, and the majority 54% from Asia. Western manufactures its products in California and in Asia. In addition, many of its customers manufacture their products in Asia. Further, Western states that its growth will continue based on total exabytes (EB) shipped, growing from 600 EB in calendar 2012 to at least 5,900 EB by calendar 2020, representing a 34% compounded annual growth rate. Western believes EB growth is the most relevant measure of the growth potential for the industry and the company. According to Western, SSDs represent only 5% of the EBs shipped industrywide.
Western's gross and operating margins have declined slightly over the last four quarters from the previous four quarters. Net profit margin and net income were cut in half due to a legal settlement of $681 million during the second quarter with Seagate over patent infringement. The company also incurred $138 million in employee restructuring costs. Since these costs are short term in nature, profits should rebound.
Western's operating cash flow margin last 12 months (LTM) trend picked up from a 20% average to 24% of revenue in the last four quarters. Free cash flow nearly doubled during this time to $2.31 billion. We expect even stronger cash flow in future periods since the onetime costs have ended. More importantly, earnings quality continues to improve, which benefits cash flow.
Earnings per share last quarter were -$1.13 due to the unusual, onetime legal expense. However, Western's EPS trend after adjusting for this onetime event is very strong. Western's four-quarter days sales outstanding (DSO) has dropped from 49 to 44 days, and average receivables as a percentage of revenue has dropped from 54% to 47%. These trends indicate that WDC isn't stuffing the channel or aggressively recognizing revenue.
Days in inventory are up to 40 days from 35 days year over year, but inventory value has dropped 2% from a year ago. For the past four quarters, average inventory as a percentage of revenue was up only 3% to 32% from the previous four quarters. Finished goods inventory has nearly doubled over the last four quarters, but this is likely a conscious decision to have ample product on hand to satisfy anticipated growth in orders. One risk is that if demand doesn't materialize, prices would likely have to be cut to move inventory and margins would be pinched.
At $1.725 billion, long term debt has been paid down by $230 million over the year, and the debt to capital ratio now stands at a modest 20%. Western's shares outstanding have also dropped during the year by over 90 million shares, which will benefit EPS in future periods. While this is a relatively low source of earnings growth, free cash flow is being used for buybacks, and not debt, which is positive.
Wall Street's consensus earnings and revenue expectations are low, which gives the savvy investor hope for gain. Western's fiscal year starts with the June quarter. For the September quarter, EPS is at $2.05 versus last year's $2.36, and yearly estimates are $8.14 versus $8.53. Revenue is estimated to be $3.78 billion for the quarter, less than last year's $4.04 billion. Annual revenue estimates are similarly lower for the year, at $15.02 billion versus $15.35 billion last year.
For the September quarter, Western expects overall hard drive industry shipments to increase modestly to approximately 135 million to 140 million units from the June quarter's 133 million units, primarily due to a seasonal increase in consumer electronics and branded product shipments. The company expects revenue in the September quarter to remain flat or increase slightly from the June quarter reflecting modest price declines and a seasonal change in business mix.
WDC is trading at less than one times sales and five times cash flow. While more expensive than in 2012, expectations are still modest for the company. Since the start of 2013, Western's stock has risen nearly 49.6%, from $43.44 to $65 currently. This is ahead of the revenue growth trend, but the macro trends in information storage emit optimism for Western's future.
June 28, 2013
June 28 , 2012
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Foolish bottom line
Western Digital will continue to quench our thirst for knowledge and understanding -- and robust data storage solutions -- into the foreseeable future. While the stock price has outpaced the market in 2013, expectations are still low enough that if the company reports upside prices, further share gains can be had.
The article Will Western Digital Fill the Void? originally appeared on Fool.com.Fool contributor John Del Vecchio, CFA is the index provider to the Forensic Accounting ETF (FLAG). He has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Intel. It also 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.
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