A Quick Look at Western Digital

Western Digital (WDC) does storage; it designs, makes, and sells hard disk and flash drives. These are used from PCs/notebooks, consumer electronic products, all the way to enterprise servers.

The company’s 2016 investor presentation, and this 2017 update provide a good overview of the business and opportunities.

WD has a history of bolstering its storage offerings by arguably decent acquisitions. It has morphed from a pure HDD play to a more general storage play over the past 10 years.

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The company’s presentation also lays out positive and negative factors.

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Headwinds

  • secular decline in PC and notebook industries; but the company expects the storage portion of this market to work out better
  • HDD industry is essentially a duopoly (with Seagate); but overall storage industry (particularly HDD) is cyclical
  • commodity product; no durable competitive advantages

Tailwinds

  • in the near term, HDD to remain dominant fraction of total stored data
  • decent management, good acquisition and capital allocation record
  • increased demand due to “big data”, more digitalization
  • datacenters, cloud computing

Valuation

The company lays out numbers to anchor a valuation.

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  • TTM revenues are ~$19.5B (up from $8B in 2008); EBIT is $2.6B (up from $1B in 2008). EPS numbers are noisy, but FCF is indicative of a cash generating business.
  • Share count has increased from 226M to 301M over the past 10 years.
  • Historical tax rate has been 7-12%, in line with future expectations. Probably should not expect tax bill to help much.
  • Total debt is $13.1B (about 2.75x EBITDA), peaked at $17B in 2016. WDC is develering. Interest expenses are currently ~$800M (compared with EBIT of $2.6B). Debt looks manageable, especially when compared to competition like Seagate, which has a much more levered balance sheet.

The adjusted FCF/sales has been 13-14% (in line with target). Sales growth is expected to be low single digits.

If we use FCF/sales = 13%, sales growth = 3%, then FCFF/share = $9.05. Subtracting the $2.75 of interest payments/share, we get FCFE for the next year of $6.30. Using the Gordon growth model with a hurdle rate of 10%, we get a target price of $85.

If we use less conservative numbers (FCF/sales = 13.5%; sales growth = 3.5%, and interest payments of $2.50 from continued delevering), we get a target a target price of $115.

Thus, the range of values is probably between $85-$115. Currently, it is trading below the lower end of this range.

 

 

 

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