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No Surprises In Western Digital's (NASDAQ:WDC) Q1 Sales Numbers But Quarterly Guidance Underwhelms


Full Report / November 02, 2021
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Leading data storage manufacturer Western Digital (NASDAQ: WDC) missed analyst expectations in Q1 FY2022 quarter, with revenue up 28.7% year on year to $5.05 billion. Guidance for the next quarter also missed analyst expectations with revenues guided to $4.8 billion, or 8.35% below analyst estimates. Western Digital made a GAAP profit of $610 million, improving on its loss of $60 million, in the same quarter last year.

Western Digital (WDC) Q1 FY2022 Highlights:

  • Revenue: $5.05 billion vs analyst estimates of $5.05 billion (small miss)
  • EPS (non-GAAP): $2.49 vs analyst estimates of $2.44 (1.93% beat)
  • Revenue guidance for Q2 2022 is $4.8 billion at the midpoint, below analyst estimates of $5.23 billion
  • Free cash flow of $224 million, down 71.7% from previous quarter
  • Inventory Days Outstanding: 95, in line with previous quarter
  • Gross Margin (GAAP): 32.9%, up from 22.2% 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.

Western Digital’s peers and competitors include Seagate (NASDAQ:STX), SK Hynix (KOSI:000660), and Samsung (KOSI:005930).

Memory Semiconductors

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. Read More There are two main types of memory chips: dynamic random access memory (DRAM) and Flash memory (NAND). In any electronic device where a processor or a graphics chip is conducting a task using data, it needs to read the data from where it is stored, known as memory. Smartphones, PCs, and data centers account for more than two thirds of memory demand. DRAM is “volatile” memory, it is a semiconductor that requires an electric charge to retain data – it is the type of memory commonly used in PCs. The advantages of DRAM are the speed at which a CPU/GPU can access the data and its long useful life. Unfortunately, “volatile” means it only can hold data temporarily when it is powered. By comparison, flash memory or NAND is “non-volatile” memory, which means that it saves data when power is removed, making it commonly used in almost every mobile device, along with USB flash drives. Its smaller form factor and greater storage capacity has made NAND-powered solid state drives (SSDs) the long term replacement for the original computing storage device, the hard disk drive.

Sales Growth

Western Digital's revenue has been declining over the last three years, dropping annualy on average by 2.62%. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $3.92 billion to $5.05 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).

Western Digital Total Revenue

Despite missing analyst estimates this quarter, 28.7% revenue growth for Western Digital's was still solid.We are still in the early days of the upcycle for Western Digital, as this was just the 2nd quarter of year on year growth.

Western Digital believes the growth is set to continue, and is guiding for revenue to grow 22.3% YoY next quarter, and Wall St analysts are estimating growth 17.6% 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.

Western Digital Inventory Days Outstanding

This quarter, Western Digital’s inventory days came in at 95, 9 days above the five year average, suggesting that inventory levels are staying higher than what we used to see in the past.

Pricing Power

Western Digital's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 32.9% in Q1, up 10.7 percentage points year on year.

Western Digital Gross Margin (GAAP)

Western Digital' gross margins have been trending up over the past year, averaging 28.5%. This is a welcome development, as Western Digital's margins are below the group average, potentially pointing to improved demand and pricing.

Profitability

Western Digital reported an operating margin of 18.8% in Q1, up 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.

Western Digital Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 13.5%. A welcome development for Western Digital, 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 113% over the next twelve months.

Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Western Digital's free cash flow came in at $224 million in Q1, up 14.2% year on year.

Western Digital Free Cash Flow

Western Digital produced free cash flow of just $1.15 billion in the last year, which is only 6.01% 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 has reported an average return on invested capital (ROIC) of just 6.7%. This suggests it may struggle to find compelling reinvestment opportunities within the business.

Key Takeaways from Western Digital's Q1 Results

With a market capitalization of $16.8 billion, more than $3.29 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.

We were very impressed by the strong improvements in Western Digital’s gross margin this quarter. And we were also glad to see the improvement in operating margin. On the other hand, it was unfortunate to see that the revenue guidance for the next quarter missed analysts' expectations and it missed analysts' revenue expectations. Overall, this quarter's results still seemed pretty positive and shareholders can feel optimistic. The company currently trades at $54.18 per share.

Is Now The Time?

When considering Western Digital, 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 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 gross margin indicate some combination of pricing pressures or rising production costs, and its return on capital isn't as high as we'd like to see.

Western Digital's price to earnings ratio based on the next twelve months is 5.2x. 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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