Western Digital: Revenues Take A Hit As PC Sales Plunge

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Western Digital (NASDAQ:WDC) announced its Q4 FY 2013 earnings on July 24, where it reported a 22% decline in revenues on a year-over-year (y-o-y) basis to $3.7 billion. [1] The company shipped a total 59.8 million hard disk drives (HDD), a significant decline from 71 million shipped in the same period a year ago. As mentioned in our pre-earnings note, a continued decline in PC and notebook sales weighed on its HDD shipments. However, shipments in non-PC businesses, particularly consumer electronics and branded products like gaming consoles, DVR backups and wireless backup networks, remained strong on a y-o-y basis. Revenues got some support from a 20% y-o-y increase in average capacity per drive to 800 gigabytes (GB). [2] However, average capacity per drive declined slightly on a sequential basis, which could be of some concern.

An anticipated decline in average selling prices (ASPs) also weighed on growth. The ASP per hard drive was $60 for the quarter down from $65 a year ago but close to last quarter’s ASP of $61. This weighed on gross margins as well, which declined to nearly 28% from around 31% a year ago. However, despite the slight decline in ASPs, margins were stable on a sequential basis due to better product mix and cost improvements. Western Digital generated over $550 million in free cash flow as capital expenditures halved on a yearly basis. Net cash (after subtracting debt from available cash) rose to $2.35 billion.

The storage company expects Q1 FY 2014 revenues in the range of $3.7 billion to $3.8 billion down by 5%  from the previous year due to expected weak prices. However, the addressable market is expected to be better on a sequential basis. The stock, which has appreciated a whopping 100% in the last one year, lost 10% before recouping some of the losses.

We are updating our $64 price estimate of Western Digital to reflect earnings.

See Our Full Analysis Of Western Digital

Markets To Improve Going Forward

According to IDC, PC and notebook sales dropped over 10% last quarter making it the longest ever period of a sustained decline. It is attributed to slowing demand from emerging markets, consumer softness in mature markets and IT spending cuts amid a weak macroeconomic environment. Cannibalization from tablets is another reason for the weak PC market. While we expect soaring tablet sales to weigh on PC demand, PC sales are expected to improve in the second half of 2013 as enterprises and retail users upgrade computers once spending recovers. Western Digital expects the total addressable market (TAM) to improve in the current quarter to 135 million-140 million HDDs. While the figure is close to a TAM of 139 million in the same period last year, it is slightly better than the TAM of 132 million in the June quarter. However, we don’t expect Western Digital to gain significant market share going forward.

While Western Digital recently launched the thinnest (7 mm) 1 TB HDD, its rival Seagate responded with the thinnest drive (5 mm) for 500 GB. Since the HDD market primarily comprises PC and notebooks, the average capacity is close to 500 GBs. This could slightly benefit Seagate in the near term. (Read Seagate Targets Ultrabook And Tablet Markets With Thinnest Ever Hard Disk Drive). Nonetheless, Western Digital is catching up with Seagate in hybrid drives. It announced a collaboration with SanDisk, a flash memory market leader, two months back to launch its first hybrid drive (Read Western Digital And SanDisk Target Big Potential In Hybrid Drives With Collaboration). Hybrid drives have performance and size comparable to SSD drives while being relatively cheaper. They provide higher input/output operations per second (IOPS) and increase the responsiveness of HDDs by adding solid-state storage for advanced caching of large, frequently used chunks of data.

Enterprise Storage Requirements Growing Rapidly, Western Digital Well Placed To Tap The Market

The enterprise business is expected to demand high capacity storage solutions on the back of demand from cloud storage providers. The high growth rate of digital content, popularity of remote storage services, and adoption of cloud computing environments are all driving storage demand from data-centers (Read our note Plunging PC Sales Sink Seagate Even As Enterprise Business Lends Support).

We believe Western Digital is well-placed to tap the growing storage demand in the enterprise market. Western Digital will soon be widely launching (expected in the second half of 2013) its new helium filled drives. These drives consume up to 23% less power while allowing for a nearly 40% jump in capacity. We expect the drive to gain strong traction over HDDs in the traditional enterprise market. Further, as aforementioned, it has already launched  its first hybrid drive. As more user data moves to cloud, servers will need to support higher IOPS. Enterprises are expected to demand faster drives at low costs.

In addition, it is focusing equally on solid state drives to drive long term growth. Western Digital acquired two companies in the SSD space to strengthen its presence. The sTec acquisition complements its enterprise SSD product portfolio as it will give Western Digital ready access to its PCIe SSDs and entry into the server flash market (Western Digital To Acquire sTec To Expand Its SSD Offerings). With the VeloBit acquisition, Western Digital will be able to better distinguish its data-center storage solutions (Western Digital Gets Aggressive In The Enterprise SSD Space). VeloBit’s SSD caching software increases the speed of applications as well as server density by providing better input/output performance. This results in higher efficiency of both processor and storage resources which will continue to drive growth for Western Digital.

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Notes:
  1. Fourth Quarter Fiscal 2013 Quarterly Fact Sheet, Western Digital, July 24 2013 []
  2. Western Digital Management Discusses Q4 2013 Results – Earnings Call Transcript, Seeking Alpha, July 24 2013 []
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