WDC was a good buy a few weeks ago; now it’s a GREAT buy

August 9, 2018

WDC was a good buy a few weeks ago; now it’s a GREAT buy

In late July, and just before they released their latest quarterly earnings report, I wrote about Western Digital Corporation (WDC) and the fact that the stock had dropped more than 28% below its all-time high at around $108. The stock was around $75 per share then, and following their earnings report, the stock plunged even more; as of this writing the stock is just a little above $66 per share. At the end of July, I thought the stock was a nice buy; after reviewing the stock’s latest earnings information, and taking the latest drop into account, I think it’s an even bigger bargain now.

So what’s been driving the latest plunge (almost 11.5% since my last post about this stock)? Sometimes, the stock market makes sense – or at least, you can tie what a stock is doing at a given time to specific news, or to something about the underlying company that has some semblance of logic to it. Often, though, it’s downright maddening. I’ll admit that when I first saw WDC drop below $70 I struggled to tie it to anything concrete. I’ve kept digging, and while I think I’ve found a couple of threads to tie the decline to, the logic behind one of them makes me shake my head.

Shortly after my post, WDC published its latest quarterly earnings report. The numbers were good across the board – every fundamental measurement I use in my analysis remained very healthy or improved, including the company’s Book Value. It was right after that report, however that the stock started to drop. At the same time, WDC’s only real competitor in the HDD space, Seagate Technology Plc (STX) released their own earnings report. STX’s report reflected a reality that seems to be scaring investors about either company, because sales of HDD drives continues to decline. In the consumer space, in particular, HDD clearly looks like a dying breed. And while STX is focusing more and more on the only market where HDD sales remain healthy – the enterprise, cloud server storage space – they don’t have a plan to evolve their business beyond that. WDC, at least in part, looks like a victim by association of STX’s poor report, which also prompted downgrades on that stock from analysts. That’s the part that makes me scratch my head, because anybody that thinks STX is in a better position than WDC to stay relevant has to be smoking something.

The other thread I’ve found, and that the market seems to be teeing off on, is the fact that competition in the SDD and NAND space – memory types that are built on solid-state technology, and a major piece of WDC’s evolution strategy – is intensifying. WDC bought SanDisk in 2016 primarily because they knew that staying pat with HDD technology was a loser’s game; acquiring SanDisk immediately put them at the front of the SSD and NAND chip pack. There is market data that suggests supply of SSD and NAND chips is higher than demand right now. With more companies like Micron Technology (MU), Intel Corporation (INTC) and others making forays into the space, it isn’t a given WDC will maintain their leadership position in this segment. Intensifying competition, along with high supply clearly is also playing a role right now in the stock’s decline.

Competition in any business segment is a normal thing, and while that increases the pressure on any company, a good management team doesn’t shy away from it. I really like WDC’s strategy, and I think that in the long run they’re doing the right things to keep their business growing. Their fundamentals remain excellent in the meantime, which really means that if the stock was a nice buy at $75, it’s a great buy now.

Fundamental and Value Profile

Western Digital Corporation (WDC) is a developer, manufacturer and provider of data storage devices and solutions that address the needs of the information technology (IT) industry and the infrastructure that enables the proliferation of data in virtually every industry. The Company’s portfolio of offerings addresses three categories: Datacenter Devices and Solutions (capacity and performance enterprise hard disk drives (HDDs), enterprise solid state drives (SSDs), datacenter software and system solutions); Client Devices (mobile, desktop, gaming and digital video hard drives, client SSDs, embedded products and wafers), and Client Solutions (removable products, hard drive content solutions and flash content solutions). The Company develops and manufactures a portion of the recording heads and magnetic media used in its hard drive products. WDC’s current market cap is $19.9 billion.

  • Earnings and Sales Growth: Over the last twelve months, earnings  grew more than 29% while revenue growth was modest, posting an increase of almost 6%. WDC operates with a narrow margin profile of about 1%. By comparison, STX’s margins are around 10%. I believe the difference is a reflection of the company’s differing approach to growth; STX focuses almost exclusively on the higher margin aspect of increasing enterprise demand, while WDC takes a two-tiered approach by meeting enterprise demand for HDD drives while also pushing hard on innovation and evolution with SSD storage.
  • Free Cash Flow: WDC’s free cash flow is very healthy, at almost $3.4 billion. That translates to a free cash flow yield of almost 17%, which is much higher than I would normally expect given the company’s narrow operating margins.
  • Debt to Equity: WDC has a debt/equity ratio of .95. That number declined from a little above 1 two quarters ago, as long-term debt dropped by more than $1 billion. Their balance sheet indicates their operating profits are more than adequate to repay their debt, and with almost $5 billion in cash and liquid reserves, the company has excellent financial flexibility, which they plan to use to pay down debt, repurchase their shares and consider other strategic acquisitions.
  • Dividend: WDC pays an annual dividend of $2.00 per share, which translates to a yield of about 3% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for WDC is $38.53 and translates to a Price/Book ratio of 1.7 at the stock’s current price. Their historical average Price/Book ratio is 2.12. That suggest the stock is trading right now at a discount of a little over 19%, which is attractive; to support that opinion, the industry average is 4.6. That suggests the stock could be even more significantly undervalued right now. Using a long-term target price above $140 is probably over-optimistic since the stock’s highest price was reached in late 2014 around $110; however if the company’s evolution strategy is correct, as I expect it to be, that historical high is useful.

Technical Profile

Here’s a look at the stock’s latest technical chart.


  • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s intermediate downward trend, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock broke below strong support from repeated low pivots since late last year at $75, which has really driven the stock’s bearish momentum. The Fibonacci analysis shown on the chart above makes it hard to see where the stock’s next support level is likely to be. The upward trend that ended in March actually began in March 2016 at a low of around $35 per share; applying the same Fibonacci calculations to that trend puts the 61.8% retracement level at around $62.50, meaning that the stock is nearing the next important support area.
  • Near-term Keys: The stock is already offering a significantly discounted price relative to where I think it’s long-term potential lies. The truth is that if you went long on this stock in late July, you’re probably trying to decide what to do to manage the position now. I think there is more than adequate argument to hold on and ride out the stock’s current downward trend; but if you want to limit your risk, using a stop loss 25% below your purchase price would be a smart, conservative approach. If you’re thinking about trying to short the stock or start working with put options to take advantage of downside, the best signal for that kind of trade came at the end of July, so that opportunity has come and gone. The next signal for a bearish trade would come if the stock continues to break down and drops below $62. That could see the stock drop another $10 lower to around $51 or $52.