Western Digital Corporation (NYSE:WDC)

10/06/2010

 
October 7, 2010
Current Price – US$28.78


Admittedly, I make the call on Western Digital Corporation (WDC) with some degree of trepidation. The company produces hard drives and solid state drives for manufacturers of computers, storage systems and consumer products, as well as, external hard drives for retail distribution. This means that it operates in a highly competitive industry that is subject to disruptive technological changes from both its competitors and its customers, and has high cyclical volatility. However, WDC does hold a very strong position with respect to market share (approximately 30% of market with revenues of $9.8B), brand name and reputation and is trading at an attractive valuation relative to historical multiples and projected earnings. Further, while the company does not presently pay a dividend, it has been generating large amounts of free cash flow ($1.2B in 2010) that will need to be put to productive use or returned to shareholders. This suggests the possibility of either a repurchase of shares or declaration of a special dividend at some point in the near future. 

While the fundamental drivers behind growth in demand for storage products (increased video storage, mobility, and emerging markets growth) remain strong, it remains an open question and concern as to if/when solid state storage devices catch up to WAG’s hard drives in terms of cost and capacity, and whether the company will be able to main its competitive advantages in transitioning to new technologies. 

Again, while this company appears to be attractively priced, have a very strong balance sheet and strong fundamental drivers for growth, it comes with a degree of market/technological uncertainty and cyclical volatility that may discourage less intrepid investors.


Valuation

Based on a blend of valuation methods (discounted cash flows, dividend discount model and, historical and industry price ratios) I arrive at a current valuation for Western Digital Corporation of US$39.78.

Expected return should this price be realized in the markets within the next 12 months would be:

Price yield         38.9%
Dividend yield     ----%
Total return       38.9%


Risks

Listed below are some of the key risks faced by the company. For a more complete discussion of risk, refer to the company’s annual report and 10K filing.

Customer Concentration and Consolidation – 53% of revenues are derived from 10 customers. Loss of a key customer, or consolidation among the customer base, could negatively impact operating results.

Global Economic Conditions – A prolonged economic downturn could result in a decrease in revenues and an increase in operating costs adversely affecting operating results.

Markets and Technical Expansion - Entry into additional storage markets and products is complex and, if WAG is unable to successfully adapt, may lead to an erosion of competitive advantages and earnings.

Technological Innovation - Current or future competitors may gain a technology advantage or develop an advantageous cost structure that WAG cannot match.

Operational Concentration - Manufacturing operations are concentrated in a small number of large facilities subjecting the company to substantial risk of damage or loss if operations at any of these facilities are disrupted.


The Numbers

Share Price ($US)   28.78 
Market Cap ($US B)   6.5 
No. Shares (M)   233 
ROE   35.0%
ROA   21.9%
P/E Ratio   4.7
Price/Sales Ratio   0.7
Price/Book Ratio   1.4
Current Ratio   2.3
Interest Coverage   169
Total Debt/Equity   8.5%


Analyst – David Scollon

Disclosure - At publication of this analysis I hold no position in this security, but may take a long position in the future. I do not take short positions in any of the stocks reviewed on this site, nor do I receive any compensation from the companies studied for publication of my opinions.

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