Investment Thesis
Western Digital Corp. (NASDAQ:WDC) is scheduled to announce earnings later this month on the 25th of April. In continuity with my recent theme of windows to play on the memory recovery, I think Western Digital should be on investors’ radar for 2024, more particularly ahead of their third quarter of FY24 earning report, as I see a beat and raised guidance ahead for the company.
Western Digital is a semi player with ~$24B market cap and consolidated position in the storage market; management defines itself as “a leading developer, manufacturer, and provider of data storage devices based on both NAND flash and hard disk drive technologies.” I think Western Digital’s portfolio across flash-based products, or Flash, and hard disk drives, or HDDs, makes it positioned to grow top-line with the current recovery underway in the memory/storage market. To understand why this year’s recovery takes such a spotlight in my coverage, it must be noted that last year, we saw a severe downward cycle for the entire memory and storage space, both in terms of steep declines in pricing and unit volumes sold. Western Digital, Seagate (STX) (another storage player with more focus on the HDD business), and Micron (MU) felt the heat early last year, as shown in the graph below on the three-year chart for the stocks against the S&P 500.
What’s different now is that the market corrected, and it corrected deeply. This means that customers worked through the built-up inventory, and the post-correction environment benefited from AI-related momentum driving end demand, which is good news for Western Digital. I think the stock should trade higher post-earnings this quarter as the storage market recovers from its cyclical downturn last year. I see more upside to current consensus numbers for Western Digital’s top-line growth and gross margins.
A lot of this positive outlook on the stock has been recognized and factored into the stock price performance over the past three months, as shown in the graph below. The stock was also pushed higher after Micron reported in late March. So, I understand why investors might think the rally is over, but I think we still have some more upside to go, mainly because of improved pricing dynamics that should support better-than-expected revenue this quarter.
Western Digital’s Value Proposition
The company’s main business is split pretty evenly between the Flash and HDD markets; the former accounts for 56% of total net revenue, while the latter accounts for 44%. In their most recent quarter, the second quarter of FY24, management reported HDD sales up 14% sequentially and Flash sales up 7% sequentially; the strong quarter-over-quarter growth, especially for the HDD sales (which were down sequentially a quarter prior) comes from end market strength in cloud and better average selling price or ASP after the downturn last year. I think Western Digital will maintain this upward sequential trend into the second half of its FY24 based on two factors: better pricing and demand dynamics and the company’s split.
Let’s dive into the first reason: better pricing and demand dynamics. Since Micron reports its earnings results for the three months prior so early in the quarter, I like to use it as a forward indicator to gauge the health of the demand environment. And, it’s no secret that Micron came out of the quarter with flying colors, with sales up in the high double digits quarter-over-quarter by 18%. In late December, Gartner reported the following regarding the comeback from last year’s steep downturn: “The worldwide memory market is forecast to record a 38.8% decline in 2023 and will rebound in 2024 by growing 66.3%.” In my opinion, this extends very visibly to the storage market. HDD market TAM is expanding as a result of the demand for “high-capacity portable and desktop hard disk drives.” The uptick for both HDD and Flash demand is also supported by the heightened need for chips that support AI workloads, which again is good news for Western Digital because AI is one of the exceptions to the challenging demand environment for the semi industry in 1H24.
Western Digital’s end market exposure also makes it better positioned to leverage this increased demand for HDD and Flash; the company has three main end markets: Cloud, Client, and Consumer. The bulk of revenue comes from Client, but I think the Cloud end market will make a comeback in 2HFY24. Western Digital’s 10-Q filing notes that “Cloud represents a large and growing end market comprised primarily of products for public or private cloud environments and enterprise customers, which we believe we are uniquely positioned to address as the only provider of both Flash and HDD.” This inspires, in my opinion, confidence in the company’s future growth as the AI total addressable market expands.
Now, we turn to the second reason I see more upside: the split. The company announced in late October that it would be separating its HDD and Flash businesses; according to the press release, “Our HDD and Flash businesses are both well positioned to capitalize on the data storage industry’s significant market dynamics, and as separate companies, each will have the strategic focus and resources to pursue opportunities in their respective markets.” Also worth mentioning is the additional value this unlocks for Western Digital shareholders, enabling them to gain on the upside on two fronts. I think this was a very calculated and clever move from management to boost confidence in the stock and both HDD and Flash portfolios. Now, the company is on track for the split to happen in the second half of 2024. I think most of the initial upside from the split has been factored into the stock, but I still see more upside in 2H24 upon its completion.
Attractive Valuation
Western Digital is very attractive at its current valuation, in my opinion, based on the relative methodology of valuing stocks in my coverage universe. Western Digital trades at a Price/Earnings ratio of 27.8, lower than the peer group average ratio of 30.86, according to data from Refinitiv shown in the table below. I think investors have a window of opportunity for Western Digital ahead of earnings, as I believe the stock will trade higher in the second quarter of CY2024.
What Could Go Wrong?
In my opinion, Western Digital is at risk of reporting a wider adjusted loss this year due to the structural changes underway in its plan to split the business. I continue to believe the HDD and Flash demand is healthy but think there could be a temporary bump in the road; Reuters reported in late January that the company “posted a wider second-quarter loss… due to the impact of structure changes the company implemented in its flash and HDD businesses.” I think a lot of the optimism about the split has already been priced into the stock, and so I think there is a slightly higher risk in the current quarter that investors could be taken aback by the operating expenses. I don’t think this is a reason to shy away from the stock, however, as Western Digital’s Flash and HDD segments continue to benefit from the end-demand recovery inspired by the AI boom.
What’s Next?
In my opinion, Western Digital should be on investors’ watchlist for 2024. I think the stock is generally overlooked by retail investors and seek to reverse that. Management is now guiding for the March quarter sales to grow 6% to 12% sequentially to $3.2-$3.4B, easily beating consensus expectations of $3.09B. To top it off, management also expects sequential growth in HDD business, supported by both better pricing and unit sales. Flash sales, on the other hand, are expected to decline sequentially in terms of bit shipments, but I think that drop will be offset by a better average selling price. All in all, I think Western Digital’s pros outweigh its cons for 2024. I think investors should keep an eye out specifically for the improved average selling price in the current quarter, which is my indicator for the health of the storage space recovery in 2024.