Leading data storage manufacturer Western Digital (NASDAQ: WDC) reported Q3 FY2022 results that beat analyst expectations, with revenue up 5.89% year on year to $4.38 billion. Guidance for next quarter's revenue was $4.6 billion at the midpoint, which is 1.14% above the analyst consensus. Western Digital Corporation made a GAAP profit of $25 million, down on its profit of $197 million, in the same quarter last year.
Western Digital Corporation (WDC) Q3 FY2022 Highlights:
- Revenue: $4.38 billion vs analyst estimates of $4.33 billion (1.03% beat)
- EPS (non-GAAP): $1.65 vs analyst estimates of $1.49 (11% beat)
- Revenue guidance for Q4 2022 is $4.6 billion at the midpoint, above analyst estimates of $4.54 billion
- Free cash flow of $148 million, down 63.6% from previous quarter
- Inventory Days Outstanding: 104, up from 102 previous quarter
- Gross Margin (GAAP): 26.9%, in line with 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).
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 3.69% annually. But as you can see below, last year has been stronger for the company, growing from quarterly revenue of $4.13 billion to $4.38 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).
While Western Digital Corporation beat analysts' revenue estimates, this was a very slow quarter with just 5.89% revenue growth. This marks 4 straight quarters of revenue growth, implying we are mid-cycle for Western Digital Corporation, as a typical upcycle tends to last 8-10 quarters.
Western Digital Corporation's revenue growth is expected to go negative next quarter, with the company guiding to decline of 6.5% YoY next quarter, but analyst consensus sees growth of 5.65% 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 104, 14 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 26.9% in Q3, down 0.2 percentage points year on year.
Western Digital Corporation' gross margins have been trending up over the past year, averaging 30.6%. 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 14.8% in Q3, up 4.9 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 17.1%. 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 $148 million in Q3, down year on year.
Western Digital Corporation produced free cash flow of $1.57 billion in the last year, which is 8.18% of revenue. It's good to see positive free cash flow, since that allows it to strengthen its balance street, but we wouldn't want to see its free cash flow yield drop much lower.
Over the last 5 years Western Digital Corporation has reported an average return on invested capital (ROIC) of just 6.35%. This suggests it may struggle to find compelling reinvestment opportunities within the business.
Key Takeaways from Western Digital Corporation's Q3 Results
With a market capitalization of $15.6 billion, more than $2.5 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 impressed by how strongly Western Digital Corporation outperformed analysts’ earnings expectations this quarter. And we were also glad to see the improvement in operating margin. On the other hand, it was less good to see that the revenue growth was quite weak and the inventory levels increased a little. Overall, this quarter's results still seemed pretty positive and shareholders can feel optimistic. The company is up 3.64% on the results and currently trades at $54.55 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 gross margins are weaker than its semiconductor peers we look at and its 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 6.0x. 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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