Western Digital’s Robust Growth And Outlook Support $64 Value

Western Digital (NASDAQ:WDC) announced its Q3 FY 2013 earnings on April 24. It ended the quarter on a strong note and beat market expectations as revenues grew by over 25% on a year-over-year (y-o-y) basis to $3.8 billion. ^[1] Growing overall storage demand continued to drive the revenue growth. The storage company saw volume increase in both PC and non-PC businesses on a y-o-y basis, as it shipped a total of 60.2 million hard drives, a huge jump over the 44.2 million it shipped in the same period a year ago. Revenues also got a boost from a 35% y-o-y increase in average capacity per drive, to 810 gigabytes (GB). ^[2] A less than expected decline in average selling prices also lent support. Average selling price (ASP) per hard drive was $61 in the quarter, down from $68 a year ago, but close to last quarter’s ASP of $62.

While gross margin declined to nearly 28% from around 31% a year ago, the positive thing was that it was higher than the last quarter despite a slight decline in average selling price. This was due to better mix of products and cost improvements. Western Digital generated over $500 million in free cash flow even as it spent nearly $400 million and $190 million towards R&D and capital expenditures, respectively. This resulted into an increase in its net cash (after subtracting debt from available cash), which surpassed the $2 billion mark. The storage company expects Q4 FY 2013 revenues in the range of $3.55 billion to $3.65 billion, due to a flat-to-slightly down total available market, coupled with a seasonal change in the business mix.

After strong results, Western Digital’s stock touched new highs of $58 before retreating. We have updated our price estimate of Western Digital to $64, to reflect earnings.

See Our Full Analysis Of Western Digital

Storage Requirement Soaring With Growing High Definition Digital Content, Cloud Computing And Remote Storage Services

The increasing demand for high definition (HD) content for media consumption and rich formats such as HD DVD and Blu-Ray continue to drive demand for high capacity disk drive solutions in the end-user market. More consumers are turning to external drives to increase their existing storage capacities to create and share HD content. While PC sales are declining due to consumer softness in mature markets (the U.S. and Western Europe), slowing demand from emerging markets and IT spending cuts amidst weak macroeconomic environment, the growing demand from increasing tablet and smartphones is more than offsetting the decline. Tablet and smartphone users also consume more digital content like online video streaming, email and music, and are driving storage requirements. They are increasingly becoming dependent on network attached storage while tablets with USB ports are seeing greater adoption of external drives for additional storage capacity.

Remote storage is becoming a standard for most enterprises and has even gained traction with retail customers for services like iCloud, Dropbox, Skydrive and Google Drive. More businesses are deploying cloud computing environments in an effort to pool resources and cut costs. Owing to aforementioned factors, the revenue contribution of Western Digital’s non-PC related business is expected to grow from 35% FY 2008 to more than 50% in FY 2013.

Western Digital Well Placed To Tap The Market

In its Enterprise business, we believe Western Digital is placed to tap the growing storage demand. Currently, hard disk drives (HDD) offer a more cost-efficient alternative to solid state drives (SSD), making them a more suitable option for developing and expanding cloud infrastructures, as capacity matters more than speed. Western Digital is a leader in the enterprise HDD space and already has several high performance products to offer. The storage company is also developing new helium filled drives, which once widely launched, are expected to provide it a significant advantage over competitors. These drives consume up to 23% less power while allowing for a nearly 40% jump in capacity.

However, in the long run, SSD production costs are likely to go down significantly due to an improvement in technology. This will lead to a decline in the average selling price per gigabyte (GB) for SSDs, and cause SSDs to replace HDDs. To not get left behind, Western Digital has been focusing on enterprise SSDs as well. The company acquired Hitachi GST (HGST) in 2012, which brought a range of enterprise SAS SSD product lines. A few days back, HGST launched the industry’s first 12Gb/s SAS SSD. Further, HGST is working on the high-end PCI Express (PCIe) SSD product line. PCIe SSDs are much faster than SAS SSDs, as SAS connect to the host computer through host adapters that in turn connect to the PCIe interface. With increasing demand for speedier access, PCIe SSDs are expected to see higher growth going forward.

On the retail side, we think Western Digital is taking the right steps with its equal focus on SSDs and hybrid storage drives. We expect hybrid SSDs to gain more popularity in the near term, as they have performance and size comparable to SSD drives while being relatively cheaper. Western Digital’s wafer-thin 5mm hybrid drive are designed for use in hybrid laptops and ultrabooks. ^[3] Further, the company is continuously working on development of SSDs for retail consumers, which will help it in the long term.

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1. Third Quarter Fiscal 2013 Quarterly Fact Sheet, Western Digital, April 24 2013 [↩]
2. Western Digital Management Discusses Q3 2013 Results – Earnings Call Transcript, Seeking Alpha, April 24 2013 [↩]
3. Western digital brings wafer thin 5mm hard drives to idf we go, Engadget, Sept 12 2012 [↩]