How Sensitive Is Western Digital’s Stock To Changes In Its Gross Profit Margin?
Hard drive manufacturer and flash storage provider Western Digital (NASDAQ:WDC) has had an eventful end to 2017 with the company finally coming to an agreement with Toshiba to continue to collaborate in developing flash memory storage. In recent quarters, Western Digital has integrated SanDisk’s flash storage portfolio into its business, and that has helped company-wide gross margins to surge from 28-30% to nearly 40% as flash storage is typically a higher margin business. Given the transitioning customer preferences towards flash storage, we expect Western Digital’s gross margins to remain in the 39-40% range throughout our forecast period. Comparatively, rival hard drive manufacturer Seagate (NASDAQ:STX) still remains largely dependent on non-flash storage for a significant portion of its revenues.Accordingly, Seagate’s gross margins continue to be in the 30-32% range.
Looking ahead, Western Digital’s ability to maintain high margins and improve its profitability is important for its valuation. We have created an interactive model that details how a change in its gross margin can impact the company’s value. You can modify assumptions such as projected revenues to see how the gross margin or estimated valuation changes. The image below shows one of the key steps in identifying Western Digital’s stock sensitivity to change in its gross margin. We detail how change in gross margin impacts gross profit, which then impacts EPS and subsequently the valuation (assuming the P/E multiple doesn’t change).
We find that a 1% improvement in Western Digital’s gross margin for fiscal 2018 would imply a 2.4% upside to its near-term valuation, which we estimate using projected EPS and a forward P/E multiple. Our sensitivity analysis assumes that the increase in gross margin would not impact Western Digital’s forward P/E multiple, which currently stands at just over 11 based on Trefis estimates. However, if you disagree with that assumption, you can make changes to all input variables on the interactive dashboards platform to gauge the impact of all changes on our price estimate and EPS.
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