How Important Is Cost Of Sales To Western Digital’s Expenses And Overall Profitability?

Western Digital’s (NASDAQ: WDC) total expenses have dropped gradually from around $18.7 billion in 2017 to about $17.32 billion in 2019. As a percentage of revenues, expenses have grown, going from 97.9% in 2017 to 104.6% in 2019.
Cost of sales is the biggest expense head for the company, with it being 68.2% of revenue in 2017, before increasing to around 77.4% of revenue in 2019. This increase has led to a substantial drop in profitability, driving EPS from $1.38 in 2017 to -$2.58 in 2019.
However, with revenue expected to rise by 2021, cost of sales as % of revenue is likely to drop to 72.7%, leading to a projected rise in net income margin from -4.6% in 2019 to 1.7% in 2021.
This projected growth has helped drive a 45% rise in Western Digital’s share price since the start of December 2019.

In our interactive dashboard How Does Western Digital Spend Its Money?, we take a look at the key drivers of Western Digital’s expenses and net margins.

Western Digital’s Net Income Margins rose from 2.1% in 2017 to 3.3% in 2018, before dropping to -4.6% in 2019, owing to the semiconductor supply glut. However, margins are expected to rise in 2020 and 2021, to levels slightly below those of 2017, as the semiconductor market is expected to get back into a state of balance.

Breakdown of Western Digital’s Total Expenses

• Cost of Goods Sold has dropped from $13.02 billion in 2017 to $12.82 billion in 2019, driven primarily by a drop in revenue. However, as a % of Revenue, Cost of Goods Sold has grown from 68.2% to 77.4% over the same period, largely due to a drop in selling prices, due to an oversupply in the semiconductor and memory markets. However, this metric is expected to steadily drop to 72.6% by 2021.
  
• R&D Expense has dropped from $2.44 billion in 2017 to $2.18 billion in 2019. This metric has dropped over the past 2 years, but we expect it to rise further by 2021, as Western Digital is expected to focus on development of better memory products, with the supply demand differential expected to return to normal. As a % of Revenues, SG&A has grown marginally from 12.8% in 2017 to 13.2% in 2019.
• SG & A Expense has dropped marginally from $1.45 billion in 2017 to $1.32 billion in 2019. This metric has dropped over the past 2 years, at a rate slower than the drop in revenue, and this has primarily been due to a drop in selling prices. However we expect it to rise by 2021. As a % of Revenues, SG&A has grown marginally from 7.6% in 2017 to 7.9% in 2019.
• Other Expenses have dropped marginally from $232 million in 2017 to $166 million in 2019. Other expenses include employee termination costs, asset impairment charges and other miscellaneous expenses. This metric has dropped over the past 2 years, going from 1.2% of revenue to 1% of revenue, and we expect it to come in at 1.1% of revenue over the next 2 years.
• Non-Operating Expense has decreased from $1.19 billion in 2017 to $370 million in 2019. There was a sharp drop in 2019 due to a drop in other non-operating expenses, which include restructuring costs and other miscellaneous costs. Western Digital’s total debt has dropped from $12.92 billion in 2017 to $10.25 billion in 2019. We expect debt to drop to around $9.02 billion by 2021, with net interest expense to drop to $406 million.
• Income Tax Expense first increased from $370 million in 2017 to $1.41 billion in 2018, before dropping to $470 million in 2019. Going forward, we expect an effective tax rate of 22.5%, with income tax expense coming in at around $90 million in 2021.

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