Sunday, March 15, 2009

Hard Driving Western Digital

Western Digital Corporation “designs, develops, manufactures and sells hard drives. It sells its products worldwide to original equipment manufacturers (OEMs) and original design manufactures (ODMs) for use in computer systems, subsystems or consumer electronics (CE) devices, and to distributors, resellers and retailers. The Company’s hard drives are used in desktop computers, notebook computers and enterprise applications, such as servers, workstations, network attached storage, storage area networks and video surveillance equipment. Additionally, its hard drives are used in CE applications, such as digital video recorders, and satellite and cable set-top boxes. It markets its hard drives under brand names, including WD Caviar, WD Raptor, WD VelociRaptor, WD Scorpio, WD Elements, My Passport, My Book, My DVR Expander and GreenPower. On September 5, 2007, WD, through its indirect wholly owned subsidiary, State M Corporation, completed the acquisition of Komag, Incorporated.”



With a market share of the worldwide hard disk market of 26.9%, WDC is behind the market leader Seagate (31.8%) but ahead of Hitachi (17%) and the newly combined Toshiba/Fujitsu (16%).


JPMorgan projects a 19% decline in hard disk drive revenues worldwide to $26.3 billion as competition drives down prices and the global recession leads to a drop in shipments. Sales will not turn-around until the recession abets.


Valuation


On a price/earning basis, WDC has a history of selling at a substantial discount to the industry average. The company is currently selling significantly below its 3 year, 5 year and 7 year averages.



Conversely, WDC has historically sold at a premium on a price/book basis. Looking at price to tangible book value, the company is selling at a 1.40 multiple.



As with price/earnings, on a price to cash flow or price to free cash flow basis, current multiples are below historic averages and industry averages. However, we project free cash flow to grow to $4.17 over the next twelve months.



Consensus earnings for FY 09 are projected at $1.66, about 56.7% less than FY 08. For the year ending June 10, earnings will decline further to an estimated $1.53. Similarly, sales will decline from FY 08 levels of $8,074 million to $6,750.19 in FY 09 and $6,461.06 in FY 10.


Western Digital maintains a torrid growth rate across all metrics. Sales remain robust even with the drop in worldwide demand.


We see that WDC is able to control costs. Gross, Operating and Net margins are all above their five year averages which speaks well of management and they are not too far off FY 08 levels. Both ROE and ROA show weakness due to the decline in earnings. However, debt has not grown. Going forward, we expect to see continued pressure on margins.



Conclusion

We think that Western Digital is in a strong position to weather the current storm and emerge stronger than before. They have a broad, well-selling product mix. They have a strong balance sheet with cash representing 36% of the current market price, low debt and solid cash flow. Things will get worse before they get better.

We estimate fair market value to be $44.27 or 10.6X our estimated free cash flow. This multiple is below historic averages and provides a margin of safety. We base our estimate of fair market value on the strength of the balance sheet, very manageable levels of debt, more than adequate cash flow and the potential for WDC to make an acquisition.

Disclosure: Author has no position in any company mentioned.
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