Leading data storage manufacturer Western Digital (NASDAQ: WDC) reported Q1 FY2023 results topping analyst expectations, with revenue down 26% year on year to $3.73 billion. However, guidance for the next quarter was less impressive, coming in at $3 billion at the midpoint, being 14.2% below analyst estimates. Western Digital Corporation made a GAAP profit of $27 million, down on its profit of $610 million, in the same quarter last year.
Western Digital (WDC) Q1 FY2023 Highlights:
- Revenue: $3.73 billion vs analyst estimates of $3.61 billion (3.41% beat)
- EPS (non-GAAP): $0.20 vs analyst expectations of $0.39 (48.9% miss)
- Revenue guidance for Q2 2023 is $3 billion at the midpoint, below analyst estimates of $3.49 billion
- Free cash flow was negative $215 million, compared to negative free cash flow of $97 million in previous quarter
- Inventory Days Outstanding: 128, up from 107 previous quarter
- Gross Margin (GAAP): 26.2%, down from 32.9% same quarter last year
Founded in 1970 by a Motorola employee, Western Digital (NASDAQ: WDC) is a leading producer of hard disk drives, SSDs and flash memory.
Originally a producer of calculator chips, Western Digital refocused on hard disk drives in 1978, and created the original ATA hard disk drive standard used in PCs. HDDs were one of the most competitive, low margin, tech markets for decades until a wave of consolidation shrank the market to two main players; Western Digital and Seagate, following Western Digital’s acquisition of Hitachi Global Storage in 2015. That same year the company acquired SanDisk, one of the largest producers of flash memory.
The SanDisk acquisition brought Western Digital into a partnership with Toshiba (now named Kioxia) in Flash Ventures, the largest producer of flash memory semiconductors in the world, and diversified Western Digital’s revenues equally across HDD and flash memory, each of which today account for roughly half of its revenues.
The global memory chip market has become concentrated due to the highly commoditized nature of these semiconductors. Despite the market consolidation, DRAM and NAND are subject to wide pricing swings as supply and demand ebbs and flows. This plays itself out in the business models of memory producers, where the large, fixed cost bases required to produce memory chips in volume can become very profitable during times of rising prices due to high demand and tight supply but also can result in periods of low profitability when more supply is brought online or demand drops.
Western Digital's revenue growth over the last three years has been unimpressive, averaging 4.91% annually. Over the last 12 months the quarterly revenue declined from $5.05 billion to $3.73 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).
Despite Western Digital's revenues beating analyst estimates, this was still a slow quarter with a 26.1% revenue decline.
The company is guiding to a 38% year on year decline next quarter, while analysts are estimating a NTM revenue decline of 13.2%.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.
This quarter, Western Digital Corporation’s inventory days came in at 128, 32 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.
Western Digital Corporation's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 26.2% in Q1, down 6.7 percentage points year on year.
Western Digital Corporation' gross margins have been trending up over the past year, averaging 29.4%. This is a welcome development, as Western Digital Corporation's margins are below the group average, potentially pointing to improved demand and pricing.
Western Digital Corporation reported an operating margin of 8.21% in Q1, down 10.6 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.
Operating margins have been trending up over the last year, averaging 14.2%. A welcome development for Western Digital Corporation, as its operating margins are a little below industry average, as its cost structure isn't as efficient as it could be.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to grow 8.14% over the next twelve months, although estimates are likely to change post earnings.
Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Western Digital Corporation's free cash flow came in at -$215 million in Q1, down 195% year on year.
Western Digital Corporation produced free cash flow of just $243 million in the last year, which is only 1.39% of revenue. We think shareholders would want to see free cash flow improve as a percentage of revenue.
Over the last 5 years Western Digital Corporation has reported an average return on invested capital (ROIC) of just 5.11%. This suggests it may struggle to find compelling reinvestment opportunities within the business.
Key Takeaways from Western Digital Corporation's Q1 Results
With a market capitalization of $11.2 billion, more than $2.04 billion in cash and with free cash flow over the last twelve months being positive, the company is in a very strong position to invest in growth.
It was good to see Western Digital Corporation outperform Wall St’s revenue expectations this quarter. That feature of these results really stood out as a positive. On the other hand, it was less good to see that the increase in inventory and the revenue guidance for the next quarter missed analysts' expectations. Overall, this quarter's results could have been better. The company is down 2.23% on the results and currently trades at $34.5 per share.
Is Now The Time?
When considering Western Digital Corporation, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in the case of Western Digital Corporation we will be cheering from the sidelines. Its revenue growth has been very weak, but at least that growth rate is expected to increase in the short term. And on top of that, unfortunately its growth is coming at a cost of significant cash burn, and its relatively low return on invested capital suggests suboptimal growth prospects.
Western Digital Corporation's price to earnings ratio based on the next twelve months is 19.2x. While we have no doubt one can find things to like about the company, we think there might be better opportunities in the market and at the moment don't see many reasons to get involved.
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