Leading data storage manufacturer Western Digital (NASDAQ: WDC) fell short of analyst expectations in Q4 FY2022 quarter, with revenue down 7.96% year on year to $4.52 billion. Revenue guidance for the next quarter was $3.7 billion at the midpoint. Western Digital Corporation made a GAAP profit of $301 million, down on its profit of $622 million, in the same quarter last year.
Western Digital Corporation (WDC) Q4 FY2022 Highlights:
- Revenue: $4.52 billion vs analyst estimates of $4.57 billion (0.98% miss)
- EPS (non-GAAP): $1.78 vs analyst estimates of $1.72 (3.2% beat)
- Revenue guidance for Q1 2023 is $3.7 billion at the midpoint
- Free cash flow was negative $97 million, down from positive free cash flow of $148 million in previous quarter
- Inventory Days Outstanding: 107, up from 104 previous quarter
- Gross Margin (GAAP): 31.9%, up from 29.9% 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 Corporation's revenue growth over the last three years has been unimpressive, averaging 5.44% annually. Last year the quarterly revenue declined from $4.92 billion to $4.52 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).
It was a difficult quarter for Western Digital Corporation, with revenue declining by 7.97%, and missing analyst estimates by 0.99%. Western Digital Corporation's growth turned to declines this quarter, signaling that the current downcycle is deepening.
Revenue growth went from positive to negative this quarter, and is expected to stay negative next quarter with an estimated decline of 26.8% YoY while analysts expect revenues to turn positive over the next twelve months with growth of 4.19% over the next twelve months.
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 107, 15 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 31.9% in Q4, up 2 percentage points year on year.
Western Digital Corporation' gross margins have been trending up over the past year, averaging 31.1%. 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 15.5% in Q4, down 1.3 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 16.8%. Western Digital Corporation's margins are around the midpoint for the semiconductor industry, as its cost structure is appropriately managed.
Earnings, Cash & Competitive Moat
Analysts covering the company are expecting earnings per share to be fairly flat 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 -$97 million in Q4, down 112% year on year.
Western Digital Corporation produced free cash flow of just $682 million in the last year, which is only 3.62% 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 6.07%. This suggests it may struggle to find compelling reinvestment opportunities within the business.
Key Takeaways from Western Digital Corporation's Q4 Results
Sporting a market capitalization of $15.6 billion, more than $2.32 billion in cash and with positive free cash flow over the last twelve months, we're confident that Western Digital Corporation has the resources it needs to pursue a high growth business strategy.
We enjoyed seeing Western Digital Corporation improve their gross margin materially this quarter. And we were also excited to see that earnings outperformed Wall St’s expectations. On the other hand, it was less good to see that the revenue growth was quite weak. Overall, it seems to us that this was a complicated quarter for Western Digital Corporation. The company is down 7.77% on the results and currently trades at $46.03 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, and analysts expect growth rates to deteriorate from there. And while its sturdy operating margins suggest disciplined operating expense controls, the downside is that its growth is coming at a cost of significant cash burn and its return on capital isn't as high as we'd like to see.
Western Digital Corporation's price to earnings ratio based on the next twelve months is 6.3x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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