Friday, December 10, 2010

Is Western Digital a bargain?

The company

Western Digital (WDC) is one of the world’s largest makers of data storage products. Specifically, it is a global leader in the development and manufacture of hard drives and solid state drives for internal, external, portable and shared storage applications. The products Western Digital offers are used in computers of all kinds ranging from a notebook to high end servers. They are also used in other applications such as mobile devices and home entertainment equipment.

Picture. Inner view of a Seagate 3.5 inches hard disk drive Medalist ST33232A model manufactured in Malaysia in 1998. Copyright: Eric Gaba (Wikimedia Commons user: Sting).

Hard Disk Markets
The data storage industry is expected to ship some 660 million hard drives this year. Western Digital and Seagate (STX) compete neck to neck for the number one position in this market. Western Digital is number one in terms of shipped units, but Seagate gets more revenue as it serves the high-end enterprise sector. Western Digital employs a low-cost business model and gets lower average selling price. Combined they ship over 60% of all hard drives. Hitachi (HIT) has third largest market share (18%). The other significant players are Toshiba and Samsung.

The market is still growing. Industry observers foresee a compound annual unit growth rate of 5.6 percent for the years through 2013. The driver of this growth is simply the amount of data that needs to be stored and backed up in the world.

Threats to hard disk sales: Solid-state disks and Tablets

Picture. Mtron solid state drive. Source: Wikipedia user 76coolio.

Solid-state disks do not have moving parts like hard disks do. Therefore, they are faster in seeking data, immune to vibration and shock and also more reliable. Solid-state disks are superior to hard disks in many respects except what comes to storage capacity and price. Therefore, it will take years for solid-state disks to have significant share of the overall storage market in terms of terabits sold.
Tablets that use solid-state disks are feared to cannibalize PC and notebook sales. While this might be true to some extent, the tablets are also complementary to PCs and notebooks so the overall storage market grows leaving plenty of room for hard disks still far into the future.

Increased capital spending

According to iSuppli the hard disk companies will spend considerable amount of money in the near future on their manufacturing plants. Western Digital will spend $1.2 billion during the next five years on its plants in Malaysia. Likewise, increased capital expenditures have been announced by the likes of Toshiba, Samsung and Hitachi.

Western Digital vs. Seagate

Data source:

Seagate has higher long term debt / equity – ratio and price per book than Western Digital, but on the other hand it has higher margins and lower P/E and P/S valuations. Looking at these values, both companies look like good picks. However, I started leaning towards Western Digital as I followed the buyout talks regarding Seagate in which Western Digital seemed to have an upper hand. Also, Western Digital products populate five positions in Top 10 list of most sold hard drives in my favourite local computer dealer whereas Seagate has only two (WDC #2,3,6,7,8: STX #4,9). This fact and the fact that Western Digital is volume & cost efficiency champ, I place my bets on it at this point of time.

A closer look at Western Digital

Western Digital has very strong balance sheet. There is only tiny amount of long term debt compared to cash and cash equivalents. Subtracting long term debt from cash leaves net cash position of $2596 million or $11.30 per share.

The valuations of the company also look very attractive if the net cash is taken into account. Also, the growth rate has been phenomenal so far. Even if it reduces to 10% p.a. the company looks cheap. estimates price per free cash flow at 7.09. My own back-of-the-envelope questimate is that FCF for ongoing fiscal year will be at least $800 million (or $3.48 a share). Taking into account net cash position, I arrive to conclusion that the price of the business divided by free cash flow is 6.8. Not awfully cheap, but given the growth prospects, I think it’s a buy.

No comments:

Post a Comment