Western Digital Corporation

Transcription

1 January 28, 2015 Western Digital Corporation Current Recommendation Earnings Update: Western Digital Reports Q2 Results SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 02/27/2014 Current Price (01/27/15) $97.63 Target Price $ (WDC-NASDAQ) SUMMARY Western Digital reported better-than-expected second-quarter fiscal 2015 results. Although, revenues decreased on a year-over-year basis, earnings compared favorably. However, the company provided a tepid revenue and earnings guidance citing seasonal factors. Nonetheless, the shift toward non-pc applications, secular growth of digital data and growing exposure to the small and medium business space are long-term positives. Additionally, modest growth in TAM and higher demand for storage are expected to result in a positive earnings surprise in the upcoming quarter. Although strategic acquisitions in the SSD segment are expected to expand its offerings, competition from Seagate and SanDisk cannot be discounted. Thus, we reiterate our Neutral recommendation in the stock. 52-Week High $ Week Low $81.95 One-Year Return (%) Beta 1.33 Average Daily Volume (sh) 1,881,850 Shares Outstanding (mil) 232 Market Capitalization ($mil) $22,673 Short Interest Ratio (days) 2.35 Institutional Ownership (%) 89 Insider Ownership (%) 0 Annual Cash Dividend $1.60 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 15.5 Earnings Per Share (%) 19.6 Dividend (%) N/A using TTM EPS 12.0 using 2015 Estimate 11.9 using 2016 Estimate 10.9 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Below Avg., Type of Stock Large-Blend Industry Comp-Storage Dv Zacks Industry Rank * 28 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Sep) (Dec) (Mar) (Jun) (Jun) ,035 A 3,824 A 3,764 A 3,728 A 15,351 A ,804 A 3,972 A 3,703 A 3,651 A 15,130 A ,943 A 3,888 A 3,725 E 3,751 E 15,224 E ,961 E 4,009 E 15,354 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Sep) (Dec) (Mar) (Jun) (Jun) 2013 $2.36 A $2.09 A $2.10 A $1.96 A $8.53 A 2014 $2.12 A $2.19 A $1.94 A $1.85 A $8.10 A 2015 $2.10 A $2.26 A $1.99 E $1.99 E $8.23 E 2016 $2.29 E $2.37 E $8.95 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 RECENT NEWS Western Digital s Q2 Earnings & Revenue Beat Estimates Jan 27, 2015 Western Digital posted non-gaap earnings per share (excluding amortization of intangibles, restructuring charges and other one-time items) of $2.26, which beat the Zacks Consensus Estimate of $2.10. Also, earnings were up from $2.19 per share reported in the year-ago quarter and surpassed management s guidance range of $2.00 and $2.10 per share. Quarter Details Though Western Digital s revenues of $3.89 billion for the second quarter decreased 2.1% year over year, it came ahead of the Zacks Consensus Estimate of $3.83 billion. Reported revenues also came ahead of management s guided range of $3.75 billion to $3.85 billion, primarily due to strength in Flash Platforms solutions businesses and solid performance by the HGST and WDC divisions. During the quarter, Western Digital shipped 61 million hard drives at an average selling price (ASP) of $60. ASP for the quarter was up from $58 in the previous quarter and remained flat on a year over year basis. However, reported shipments, were down from 63.1 million in the year-ago quarter and 64.7 million HDDs shipped in the previous quarter. Also, Western Digital s market share in the total addressable market (TAM) decreased from 44% in the previous quarter to 43.4%. Market share also contracted from 44.4% reported in the year-ago quarter. Nevertheless, the company reported $187 million in revenues from the Enterprise Solid State Drive (SSD) segment, which increased from $155 million in the year-ago quarter and $156 million in the previous quarter, primarily due to higher adoption of its product range. Western Digital s top 10 customers contributed 44% to revenues compared with 42% in the year-ago quarter and 45% in the prior quarter. Western Digital s non-gaap gross margin expanded 42 basis points (bps) to 30.5% aided by better-thanexpected business mix. Operating expenses were down 5% year over year, primarily due to lower selling, general and administrative expenses, which positively impacted Western Digital s operating results. Income from operations came in at $488 million, which increased from $478 million reported in the year-ago period. Operating margin increased 52 basis points (bps) on a year over year basis and came in at 12.6% Non-GAAP net income came in at $539 million or $2.26 per share compared with $532 million or $2.19 per share in the year-ago quarter. Cash and cash equivalents were $4.9 billion compared with $5.16 billion in the previous quarter. Longterm debt during the quarter amounted to $2.25 billion. During the quarter, Western Digital generated $243 million in cash from operations compared with $827 million in the previous quarter. The company generated free cash flow of $97 million. The company repurchased stocks worth $309 million and paid dividends worth $94 million during the quarter. Guidance Equity Research WDC Page 2

3 For the third quarter of fiscal 2015, revenues are expected in the range of $3.6 to $3.7 billion. Gross margin is expected to be flat sequentially. Total operating expenses (research and development, and selling, general and administrative) are expected to be approximately $610 million. Management expects non-gaap earnings per share to be between $1.90 and $2.00 (mid-point $1.95 per share) for the March quarter. VALUATION Western Digital s shares are currently trading at 12.0X TTM earnings, a discount to the peer group average of 22.6X and the S&P 500 average of 18.9X. However, it is trading above the mid point of the historical range of 3.8X to 13.7X TTM earnings, which indicates limited possibility of further upward movement. Moreover, the shares are trading at a discount based on our 2015 forward estimates. The current 25.2% discount to the industry average for 2015 is lower than the 81.2% average discount for the historical period, indicating possibility of downward movement. Nonetheless, the secular growth of digital data and growing exposure to the small and medium business space remain the long-term positives. We therefore reiterate our Neutral recommendation on Western Digital and set a price target of $ Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Western Digital Corporation (WDC) Industry Average S&P EMC Corporation (EMC) Seagate Technology Public Limited Company (STX) NetApp, Inc. (NTAP) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Western Digital Corporation (WDC) Industry Average S&P N/A 2.0 N/A Equity Research WDC Page 3

4 Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET Equity Research WDC Page 4

5 OVERVIEW Western Digital Corporation (WDC), headquartered in Irvine, CA, is one of the largest hard disk drive (HDD) producers in the U.S. The company designs, develops, manufactures and markets a broad range of HDDs used in desktop PCs, servers, network-attached storage devices, video game consoles, digital video recorders and a host of other consumer electronic devices. The company markets its products under HGST, WD and G-Technology brands. The company operates through two independent subsidiaries HGST and WD. Western Digital sells hard drives of 3.5-inch and 2.5-inch form factors with storage capacities ranging from 30 gigabytes (GB) to 6 terabytes (TB). The company s solid-state drives (SSDs) include 2.5-inch, msata, MO-297 and CompactFlash form factors, with storage capacities ranging from 128 megabytes (MB) to 400 GB. The company also provides WD software applications, such as WD Photos and WD 2GO to the mobile computing market. The company s solutions are compatible with Apple s ios, Google s Android and Microsoft s Windows Platforms. The company markets its products and solutions through original equipment manufacturers (OEMs), distributors and retailers. In FY14, the company generated 54% of revenues from Asia, 21% from Europe Middle East Africa (EMEA) and the remaining 25% from the Americas. FY14 Revenue by Channels 13% FY14 Revenue by Geography 25% 24% 63% 54% 21% OEM Distributors Retailers Americas EMEA Asia The company competes with other hard drive manufacturers with offerings in the desktop, notebook, enterprise computer, consumer electronic devices and external storage markets. Western Digital mainly competes with companies like Fujitsu Limited, Hitachi Global Storage Technologies, Samsung Electronics Co. Ltd., Seagate Technology and Toshiba Corporation. Equity Research WDC Page 5

6 REASONS TO BUY Western Digital is the largest HDD manufacturer in the U.S. The company commands approximately 46% share in the HDD market while its main competitor, Seagate, own approximately 39% in the market. Its is worth noting that, in the last reported quarter, Western Digital s market share improved on both year over year and sequential basis, while Seagate witnessed a decline in its market share for both the periods. Western Digital expects the total addressable market (TAM) to expand on the back of a stronger gaming market and improving demand in the consumer PC segment. Moreover, strength in the commercial PC segment will have a positive impact in fiscal 2015 as well. Also, the company shipments have increased to 249 million units in fiscal 2014 compared with 242 million in 2013 and 202 million in IT research firm Gartner expects worldwide HDD shipments to grow at a 2.9% compound annual growth rate from 2013 (552 units) to 2018 (635.1 units). Western Digital s growth reflects this trend, indicating that it maintains market share. The firm also revealed that high-capacity business drives are expected to grow at a CAGR of 25.1% during the period. Western Digital s new high-capacity helium drives are likely to benefit from this growth opportunity. Prominent storage players, like Western Digital, have been expanding into the solid state drive (SSD) storage market due to the decline in the PC market. Moreover, increasing demand for thin notebooks and tablets boosted SSD shipments as well. As per technology research firm Gartner, the total SSD market is poised for considerable growth with revenues projected to more than double to $19.4 billion in 2014 from $9.2 billion in Moreover, per market research firm IHS isuppli, demand for SSDs is expected to grow at 40% in 2014 and 2015 each. SSDs are faster and more energy efficient than traditional hard drives. They also occupy less space, which makes them more suitable for mobile computing devices. The emergence of thinner laptops and tablets over the past few years has created an ideal market for SSDs, which are therefore entering the higher end of the market. SSDs are also being used in servers due to the reduction in latency, which in turn helps in faster response to real-time applications. E-commerce and financial enterprises need faster response time and thus data centers serving these clients are opting for SSDs for their obvious advantages over the traditional hard drives. The SSD segment s growth potential is a big positive for Western Digital because this could help it offset the losses stemming from the secular decline in the PC market, which does not necessarily use SSDs. Western Digital has been active on the acquisition front. The stec, Inc., Velobit, Inc. Arkeia Software Solutions and Virident Systems Inc. acquisitions have not only strengthened its small-tomedium sized business solutions but also expanded its SSD product portfolio. Notably, Western Digital derived 53% of its revenues from non-pc segment (enterprise applications, branded products and consumer electronics products) in fiscal 2014, up from 50% contributed in fiscal Moreover, Western Digital s strong cash balance ($4.80 billion) and positive cash flow ($2.82 billion) enable it to pursue an acquisition strategy. These strategic acquisitions are expected to provide the company with a competitive advantage over its peers. The company is expected to get good mileage from its cloud-based business. Cloud-based storage has become the order of the day. Consumers are increasingly using software like Google Drive, Microsoft Skydrive, Dropbox and icloud which provide the convenience of accessing content through different gadgets such as smartphone, tablets and personal computers. The access to content on multiple devices is possible because the data is stored in the cloud. This in turn is pressuring the cloud servers, resulting in a growing need to make them more efficient. For this purpose, Western Digital is developing drives filled with helium that consume 23% less power while increasing the storage capacity by 40%. The company has expanded its My Cloud solutions with My Cloud EX4, a broader portfolio of network attached storage (NAS) hard drives. My Cloud EX4 enables users to manage huge volumes of digital data, which in turn helps them to store, organize and secure photos, videos, music and important documents from computers and mobile devices. Equity Research WDC Page 6

7 My Cloud EX4 will help the company meet growing business needs with improved flexibility and security, and can be accessed through ios and Android operating systems allowing users to access their files via smartphones or tablets. Given the massive increase in cloud activity, the company is expected to find a number of takers for these products. Western Digital is in talks with the Ministry of Commerce of the People s Republic of China (MOFCOM) for the integration of Hitachi GST unit, which currently operates as a separate entity. If given the permission, Western Digital would be able to streamline its Chinese operations, such as manufacturing capacity rationalizations, which would positively impact gross margins and result in cost synergies. We are encouraged by Western Digital s endeavor to enhance shareholders value through continuous share buybacks and dividend payouts. During fiscal 2014, the company repurchased stocks worth $816 million and paid $259 million as dividends. Moreover, $1.2 billion is remaining under the stock repurchase authorization plan. These investor-friendly initiatives not only boost earnings but also instill investors confidence and loyalty. REASONS TO SELL Customer concentration is a major risk for Western Digital. During fiscal 2014, about 45% of total revenue came from its top 10 customers, which increased from 44% in fiscal The high level of customer concentration in a market with a few buyers and very low switching costs means that it is relatively easy to lose a customer. Moreover, the loss of a single order or customer affects the operating performance significantly. Therefore, the company is always under pressure to improve and maintain customer relations. Western Digital faces stiff competition from Seagate, Hitachi, Samsung and Intel in the storage market and from SSD pureplays such as SanDisk and Micron. The competition has resulted in a decline in average selling price (ASP). Western Digital s ASP declined $3 in fiscal 2014 to $58 from the year-ago period. Any further decline will impact the results if the shipments do not improve considerably. Weaker-than-expected PC shipments will likely affect Western Digital s results. According to IDC s latest report, shipments are expected to decline 3.7% in 2014, lower than 9.8% decline in the previous year, primarily due to stabilization in the U.S. economy, with tablet cannibalization tapering off. Nonetheless, the continuous decline in PC shipments raises a question regarding the future of the PC industry. The decline will badly hurt the business prospects of the companies relying substantially on PC sales. Storage sales are still largely connected to PC shipment, so this is the biggest negative for the company at the moment. However, the research firm also stated that the PC market in developed markets such as the U.S. appeared to be stabilizing but its return to growth is a distant probability. The disk drive market is highly competitive and has experienced drastic pricing pressure due to supply/demand volatility. In the near future, hard disk companies might be exposed to pressures as customers such as tablet PC makers choose flash cards for storage purposes instead of the customary hard disks. The situation may compel companies to cut hard disk prices, which may in turn hurt margins. Also, Gartner forecasts that the increase in shipments would be much more than the increase in revenues. This could also result in significant price declines. Equity Research WDC Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of WDC. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will underperform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1114 companies covered: Outperform %, Neutral %, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research WDC Page 8