Leading data storage manufacturer Western Digital (NASDAQ: WDC) reported results in line with analysts' expectations in Q2 FY2024, with revenue down 2.4% year on year to $3.03 billion. The company expects next quarter's revenue to be around $3.3 billion, coming in 3.6% above analysts' estimates. It made a non-GAAP loss of $0.69 per share, down from its loss of $0.42 per share in the same quarter last year.
Western Digital (WDC) Q2 FY2024 Highlights:
- Market Capitalization: $18.82 billion
- Revenue: $3.03 billion vs analyst estimates of $3.01 billion (small beat)
- EPS (non-GAAP): -$0.69 vs analyst estimates of -$1.10
- Revenue Guidance for Q3 2024 is $3.3 billion at the midpoint, above analyst estimates of $3.18 billion
- EPS (non-GAAP) Guidance for Q3 2024 is $0.05 billion at the midpoint, above analyst estimates of ($0.29)
- Free Cash Flow was -$176 million compared to -$557 million in the previous quarter
- Inventory Days Outstanding: 115, down from 120 in the previous quarter
- Gross Margin (GAAP): 16.2%, down from 17% in the 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.
Sales Growth
Western Digital's revenue has been declining over the last three years, dropping by 8.7% on average per year. This quarter, its revenue declined from $3.11 billion in the same quarter last year to $3.03 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).
This was a slow quarter for the company as its revenue dropped 2.4% year on year, in line with analysts' estimates. This could mean that the current downcycle is deepening.
Western Digital looks like it's on the cusp of a rebound, as it's guiding to 17.7% year-on-year revenue growth for the next quarter. Analysts seem to agree as consesus estimates call for 30.6% growth over the next 12 months.
Product Demand & Outstanding Inventory
Days Inventory Outstanding (DIO) is an important metric for chipmakers, as it reflects a business' capital intensity 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's DIO came in at 115, which is 8 days above its five-year average. These numbers suggest that despite the recent decrease, the company's inventory levels are higher than what we've seen in the past.
Pricing Power
In the semiconductor industry, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor. Western Digital's gross profit margin, which shows how much money the company gets to keep after paying key materials, input, and manufacturing costs, came in at 16.2% in Q2, down 0.8 percentage points year on year.
Western Digital's gross margins have been trending down over the last 12 months, averaging 8.4%. This weakness isn't great as Western Digital's margins are already far below other semiconductor companies and suggest shrinking pricing power and loose cost controls.
Profitability
Western Digital reported an operating margin of negative 3% in Q2, up 0.8 percentage points year on year. Operating margins are one of the best measures of profitability because they tell us how much money a company takes home after manufacturing its products, marketing and selling them, and, importantly, keeping them relevant through research and development.
Western Digital's operating margins have been trending down over the last year, averaging negative 12%. This is a bad sign for Western Digital, whose margins are already among the lowest for semiconductors. The company will have to improve its relatively inefficient operating model.
Earnings, Cash & Competitive Moat
Analysts covering Western Digital expect earnings per share to grow 168% over the next 12 months, although estimates will likely change after earnings.
Although earnings are important, we believe cash is king because you can't use accounting profits to pay the bills. Western Digital's free cash flow came in at negative $176 million in Q2, up 21.1% year on year.
As you can see above, Western Digital failed to produce positive free cash flow over the last 12 months and shareholders will likely want to see an improvement in the coming quarters.
Return on Invested Capital (ROIC)
EPS growth informs us whether a company's revenue growth was profitable. But was it capital-efficient? For example, if two companies had the same EPS growth, we’d prefer the one putting up those numbers with lower capital requirements (usually in the form of balance sheet debt and equity).
Enter ROIC, a pivotal metric showing how much operating profit a company generates relative to the capital it's invested in the business. ROIC not only gauges a company's ability to grow profits but also sheds light on a management team's ability to allocate its limited resources.
Western Digital's five-year average ROIC was 0.4%, somewhat low compared to the best semiconductor companies that consistently pump out 35%+. Its returns suggest it historically did a subpar job investing in profitable growth initiatives. The trend in its ROIC, however, is often what surprises the market and drives the stock price. Unfortunately, Western Digital's ROIC has averaged 4.4 percentage point decreases each year. This is yet another strike against the company and suggests its profitable investment opportunities are even fewer than in the past.
Key Takeaways from Western Digital's Q2 Results
We were impressed by Western Digital's EPS beat this quarter compared to analysts' expectations. We were also glad its operating margin improved. Adding to the positives was that the company's revenue and non-GAAP EPS guidance for next quarter exceeded Wall Street analysts' estimates. Many semis stocks have been strong as of late due to a spate of factors, though, and the market was likely expecting more. The stock is down 5.2% after reporting, trading at $57.22 per share.
Is Now The Time?
Western Digital may have had a favorable quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
We cheer for everyone who's making the lives of others easier through technology, but in the case of Western Digital, we'll be cheering from the sidelines. Its revenue growth has been poor over the last three years, and analysts expect growth to deteriorate from here. On top of that, its relatively low ROIC suggests it has struggled to grow profits historically, and its operating margins reveal subpar cost controls compared to other semiconductor businesses.
Western Digital's price-to-earnings ratio based on the next 12 months is 23.5x. 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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