Turnaround In Financials To Drive Western Digital Stock Higher

WDC: Western Digital logo
Western Digital

We think that Western Digital (NASDAQ:WDC) currently is a better pick compared to Seagate Technology (NASDAQ:STX). Seagate stock trades at 2x trailing revenues, double that of WDC’s 1x multiple. Does this gap in the companies’ valuations make sense? We don’t think so and we expect Western Digital to close this gap. While both companies have seen a steady rise in revenues since the lockdowns started being lifted, both have somewhat struggled over the past five fiscal years (both companies’ fiscal years end in June). Both companies saw a drop in sales in FY ’19 due to the semiconductor glut, with Seagate’s sales dropping from $11.2 billion in FY ’18 to $10.4 billion in FY ’21, and Western Digital’s sales dropping from $20.6 billion to $16.6 billion over the same period. While Seagate’s sales have bypassed their FY’18 level and currently stand at $11.5 billion on an LTM basis, Western’s Digital’s LTM revenue still stands at $18.1 billion, more than 10% lower than its FY ’18 revenue. However, the recovery in both companies’ sales has been somewhat similar since the supply glut situation started improving.

Having said that, there is more to the comparison, which makes Western Digital a better bet than Seagate, especially at these valuations. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical revenue growth as well as operating income and operating margin growth, along with the financial position. Our dashboard Western Digital vs Seagate Technology: Industry Peers; But Western Digital Is A Better Bet has more details on this. Parts of the analysis are summarized below.

1. Seagate Ahead On Revenue Growth

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Both companies over the last three fiscal years, have seen dismal sales growth, with Seagate’s sales dropping at 1.4% CAGR, and Western Digital’s at 5.9%. However, for the most recent quarter, both companies saw strong revenue growth, with Seagate’s sales jumping 34.6% YoY and 3.4% QoQ, while Western Digital’s revenues rose 28.8% and 2.7%, respectively.

However, Western Digital is a larger company than Seagate on the basis of sales, with LTM sales standing at $18.1 billion, higher than Seagate’s $11.5 billion LTM numbers.

2. EBIT margins: A Mixed Bag For Both

Seagate’s operating margins stand at 15.9% on an LTM basis, higher than Western Digital’s 10.7%. Seagate’s EBIT margins first dropped from 14.6% in FY ’18 to 12.4% in FY ’20, due to the supply glut hurting demand. Margins recovered steadily since, to around 15.9% on an LTM basis.

Western Digital saw a similar trend, with EBIT margins dropping from 17.5% in FY ’18 to as low as 0.5% in FY ’19, before rising gradually to 10.7% on an LTM basis.

However, margin change on an LTM basis vs last three fiscal years stands at 7.4% for WDC, vs 2.4% for Seagate, demonstrating Western Digital’s strong EBIT margin recovery since the pandemic hit.

3. Western Digital Ahead In Terms Of Expected Returns

Using P/S as a base, due to high fluctuations in P/E and P/EBIT, we believe Western Digital is the better choice. Western Digital’s LTM revenues of $18 billion are expected to rise at a CAGR of 9% as per our estimates, taking revenue numbers three years out to as high as $23 billion. Assuming Western Digital’s P/S ratio to remain at the conservative level of 1x, this still means that market cap would expand to $24 billion, an upside of 39%.

In comparison, given historical trends, we expect Seagate’s sales to rise at a conservative CAGR of 1.6%, taking revenue in three years to $12 billion. Considering the P/S for Seagate to then pull back to 1.7x, closer to WDC’s 1x due to its slower growth, we estimate a market cap of $20 billion for STX, indicating a downside of around 13%.

The Net of It All

Western Digital’s revenues are larger than that of Seagate, but the latter has a higher EBIT margin and is in a better financial position. However, our comparison of the post-Covid recovery above, shows that Western Digital has shown a much stronger recovery than Seagate. Given WDC’s P/S ratio of just 1x, compared to Seagate’s 2x, we believe that this gap in valuation could narrow. As such, we believe that Western Digital stock is currently a much better bet compared to Seagate stock.

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Returns Dec 2021
MTD [1]
YTD [1]
Total [2]
WDC Return -8% 0% -18%
STX Return -5% 65% 168%
S&P 500 Return -1% 24% 107%
Trefis MS Portfolio Return -2% 42% 282%

[1] Month-to-date and year-to-date as of 12/15/2021
[2] Cumulative total returns since 2017

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