What Are Western Digital's Key Growth Drivers?

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1 What Are Western Digital's Key Growth Drivers? By Adam Rogers Mar 12, :17 PM How Western Digital Stock Has Performed since Fiscal 2Q18 Results The stock has risen over 8% since fiscal 2Q18 results Western Digital (WDC) reported its fiscal 2Q18 results on January 25, 2018, and the stock price of the firm has risen 8.3% since then to $95.27 as of March 7, In fact, the stock fell to $80.09 on February 8, 2018, amid the sell-off and has risen almost 19% since then. Western Digital reported revenues of $5.3 billion in fiscal 2Q18, which ended December 2017, and non-gaap (generally accepted accounting principles) EP S (earnings per share) of $3.95. Revenue for the firm rose 9% YoY, while EPS rose over 71% in fiscal 2Q18. The significant rise in EPS was driven by a rise in gross margin, which rose 655 basis points to 43.2% in 2Q18, up from 36.7% in 2Q17. Operating expenses rose 9% YoY to $865 million from $797 million in the same period, while operating income rose 45% YoY to $1.4 billion. What did analysts expect from WDC in fiscal 2Q18? Analysts expected Western Digital to post revenue of $5.3 billion with EP S of $3.79 in fiscal 2Q18. WDC reported revenue marginally above analyst estimates, while it beat average EP S estimates by 4.2% in fiscal 2Q18. WDC has a market cap of $28.4 billion. In comparison, peer storage firms Seagate (STX), Toshiba (TOSYY), Dell Technologies (DVMT), and NetApp (NTAP) have market caps of $16 billion, $18.8 billion, $15.4 billion, and $4.4 billion, respectively. Can Western Digital Increase Revenue and Profit Margins? Analysts expect WDC s revenue to rise 7.5% in fiscal 2018 WDC s revenue rose over 9% in fiscal 2Q18, while earnings per share rose over 70% driven by a significant improvement in gross margins. WDC s revenue rose 47% in fiscal 2017 to $19.1 billion

2 driven by the SanDisk acquisition, while EBITDA (earnings before interest, tax, depreciation, and amortization) rose 149% last fiscal year. In comparison, operating profit and net income also rose 155% and 55%, respectively, last fiscal year. C an Western continue to improve revenue and profit margin in the future as well? Analysts expect Western Digital s (WDC) revenue to rise 6.4% YoY (year-over-year) in fiscal 3Q18 to $5.0 billion, 5.2% YoY to $5.1 billion in fiscal 4Q18, 7.5% YoY to $20.5 billion in fiscal 2018, and 2.7% YoY to $21.1 billion in fiscal In comparison, non-gaap (generally accepted accounting principles) EPS (earnings per share) are estimated to rise 37% YoY to $3.27 in 3Q18, 10.2% YoY to $3.23 in 4Q18, and 52% YoY to $14.01 in fiscal Analysts, however, expect EPS to fall over 10% in fiscal 2019 to $ Revenue for peer companies like Seagate (STX), NetApp (NTAP), and Pure Storage (PSTG) are expected to rise 0.8%, 6.3%, and 31.5%, respectively, in the current fiscal years. Profit margin WDC reported an operating profit of 20.6% in fiscal 2017 with a net margin of 2.1%. Analysts expect the operating margin to rise to 25.6% and net margin to rise to 5.7% in fiscal In comparison, analysts have estimated an operating margin of 23.7% and a net margin of 10.2% in fiscal Analysts expect WDC s EPS to rise at a CAGR (compounded annual growth rate) of 31.1% over the next five years. These Are Western Digital's Key Growth Drivers in Fiscal 2018 Healthy macro environment

3 Western Digital (WDC) has listed several trends and factors that are likely to drive revenue for the firm in 2018 as well as the long term. WDC believes the global economic environment is healthy with major markets such as the United States, C hina (FXI), and the European Union all experiencing rising GDP (gross domestic product). The firm expects this to positively impact IT spending as well. Increase in data creation Data creation has been growing exponentially all over the world. The value of data is also rising driven by the advancement of fast-growing technologies such as cloud computing, artificial intelligence (or AI), IoT (Internet of Things), and mobility. This growth in data also creates a need for data storage and secure storage infrastructure. At the recent JP Morgan (JP M) conference, WDC CFO Mark Long stated the company expects the CAGR (compounded annual growth rate) for data to be 30% over the next few years, which augurs well for storage companies including NetApp (NTAP), Seagate (STX), and IBM (IBM). Increase in capital expenditure spending by cloud service providers Driven by the rise in data creation, cloud service providers are increasing capital expenditure spending to accommodate this growth. During WDC s the fiscal 2Q18 earnings call, C EO Steve Milligan stated, The healthy pace of data center build out has resulted in a recent reacceleration of demand for a high capacity enterprise hard drives. Against this backdrop, we are well positioned with our powerful platform to enable our broad customer base to capture, preserve, access and transform an ever increasing diversity of data. How Western Digital Views Falling NAND Prices NAND market begins to normalize Western Digital (WDC) management stated that the global NAND (negative AND) market has started to normalize after a constrained supply scenario in With this normalization, WDC estimates the ASP (average selling prices) to fall, which WDC expects will be offset by cost declines driven by technology, improving yields, and nodal transitions. The first half of 2018 generally has experienced seasonally lower demand, while the second half is expected to see

4 rising demand. WDC has estimated the NAND to grow between 35% and 45% this year, and the firm has been able to grow at the higher end of this guidance. Demand for NAND is elastic, which suggests that demand will fall in case of a price increase. ASP has historically fallen in the long term We know that the ASP (average selling prices) for storage has historically declined. Analysts have forecasted that an oversupply in NAND will lead to a fall in ASP. According to Weston Twigg, an analyst from KeyBanc, the NAND market is expected to face oversupply in the first half of 2018, which will drive prices downwards by 3% to 5% quarter-over-quarter. Twigg also expects the NAND price decline to moderate or flatten in the second half of this year as supply growth slows. Falling NAND ASP could accelerate the adoption of solid-state drives (or SSD) in the personal computer and server markets. WDC views its ability to deliver ASP declines and cost reductions will result in the improvement in manufacturing scale and lowering of average unit cost, which then opens up new markets for the firm and provides room for technology innovation as well. Why Is Western Digital Optimistic about Helium-Based Storage

5 Products? Lowers cost of ownership Western Digital (WDC) has been able to lead the capacity enterprise market driven by its heliumbased products. According to a P RNewswire report, companies such as WDC and Netflix (NFLX) use helium to increase the speed and density of hard drives to provide faster access to data. WDC s HGST was the first to launch a helium hard drive resulting in a significantly lower cost of ownership. These hard drives reportedly reduce energy consumption by 23% and the weight-todata ratio by 30%, which results in an improvement in the product performance and an extension of the product s lifetime. WDC s high capacity 10-TB (terabyte), 12-TB, and 14-TB helium drives are seeing demand from hyperscale customers. The mid-tier capacity is in the 4-TB, 6-TB, and 8-TB range where WDC announced a new product earlier this year. 10-TB helium shipments continued to rise for WDC in fiscal 2Q18 Western Digital is experiencing strong demand in the capacity enterprise market. Shipments for its 10-TB helium drives continued to rise in fiscal 2Q18, and the firm also began to ship its 14-TB drives for hyperscale applications in the quarter ended December Western Digital expects stored data to rise from 1.4 ZB (zettabytes) at the end of 2016 to 6.2 ZB by the end of The TAM for Western Digital s Data Center Devices and Solutions segment is expected to rise from $4 billion to $23 billion over the same period. WDC s diversified portfolio of solutions is expected to help the firm take advantage of changing market dynamics. Where Does Western Digital Stand in the SSD Market? Investing in enterprise SSDs Western Digital (WDC) believes flash storage will cannibalize hard drives in the future, and the management stated that the firm is positioned to make this transition. WDC is looking to increase investments in enterprise SSDs (solid state drives) to broaden its product portfolio and cater to

6 increasing demand. SSDs are faster than HDDs (hard disk drives) and Gartner has estimated that 83% of mobile P C s (personal computers) and over 62% of desktop P C s to have SSDs as a storage product. In May 2016, WDC acquired SanDisk, which was one of the biggest NAND Flash memory suppliers used in SSDs. However, the SSD market is far more competitive than the HDD one where Western Digital has a share of over 40%. Seagate (STX) and Toshiba (TOSYY) are the other two companies in the HDD market. WDC s enterprise SSD revenue rose 13% in 4Q17 As per Trend Focus estimates, the enterprise SSD market shipped 7.2 EB (exabytes) in 4Q17, a rise of 29% YoY (year-over-year). Wells Fargo s Aaron Rakers has estimated growth rates for Samsung, Intel (INTC), WDC, Toshiba, and Micron (MU) at 40%, 21%, 13%, 9%, and 5.5%, respectively. WDC reportedly shipped 0.84 EB of data in 4Q17 and accounted for 11.7% of the total enterprise SSD market. WDC had a share of over 20% in the total SSD market, but this has fallen to below 15% driven by competition from Micron and Samsung. At the start of 2015, WDC led the enterprise SSD space with a market share of over 30%. Despite its acquisition of SanDisk, market share in enterprise SSD has fallen significantly over the last two years. Western Digital Remains Optimistic about NAND Western Digital competes with giants in NAND flash memory At the end of 3Q17, Statista estimated Western Digital (WDC) to have a 17.5% share in the NAND (negative AND) Flash memory market. WDC competes with tech giants including Samsung (SSNLF), Toshiba, Micron (MU), Intel (INTC), and Korea s (EWY) SK Hynix in this space. These

7 companies have shares of 37.2%, 17.5%, 12.9%, 6.6%, and 9.9%, respectively, at the end of 3Q17. SanDisk/WDC s share in this market has risen from 15.4% in 3Q15 to 17.1% in 3Q16. WDC acquired SanDisk in 2016 to gain traction in the NAND market. While Samsung continues to lead the NAND space, WDC is confident that its JV (joint venture) with Toshiba will allow it to compete with other players. Toshiba s JV with WDC has made the latter the leader in 3D NAND. Targeting the 3D NAND space Analysts had initially expected Samsung to lead the NAND flash memory market and leave other players way behind. While Samsung is currently the market leader in 3D NAND driven by technology leadership, WDC is fast gaining traction. WDC claims to have the highest number of bits with respect to the latest 64-layer technology compared to peers. The JV with Toshiba after the sale of its chip business to a consortium led by Bain Capital states that the former will supply advanced chips to WDC that will be manufactured in Toshiba s new plant. Western Digital will also invest in this plant and get an extension on the existing JV between the two firms. How Western Digital s Client Devices Segment Performed in Fiscal 2Q18 Revenue rose 9.5% in fiscal 2Q18 As seen below, Western Digital s (WDC) C lient Devices business generated revenue of $2.7 billion in fiscal 2Q18. This segment provides storage products like SSDs (solid-state drives) and HDDs (hard disk drives) that are being used in P C s, tablets, laptops, smartphones, and gaming consoles like Play Station (SNE) and Xbox (MSFT). Client devices accounted for almost 50% of WDC s revenue in 2Q18. Exabytes shipped by Client Devices rose to 40 in 2Q18, up from 39.2 in 2Q17. Increased demand from embedded flash and client SSD (solid state drive) products drove revenue for WDC in 2Q18.

8 Began shipments of emmc solutions WDC also started to ship its 3D flash-based emmc (embedded multimedia card) solutions in the last quarter. WDC president and COO (Chief Operating Officer) Mike Cordano stated, We began shipments of our 3D flash-based embedded solutions with a mobile and compute market including our first USF offering allowing us to address our broader market opportunity beginning this calendar year. The firm continued to experience strong demand for its client devices products from high growth segments such as connected home, surveillance, and industry verticals. Revenue in this segment rose 12.7% YoY in fiscal 1Q18 as well. Revenue growth for WDC across business segments over the last 12 months has meant an increase of 34% in the company s share price in the trailing 12-month period. In comparison, the S& P 500 (SPY) and the PowerShares QQQ ETF (QQQ) has generated returns of 15.4% and 32%, respectively, in the same period. How Does Western Digital View Exabyte Growth? Industry exabyte growth expected to rise over 50% in 2018 As seen below, Western Digital s (WDC) total exabytes (or EB) shipped rose 22.5% YoY (yearover-year) to 95.3 in fiscal 2Q18 from 77.8 in fiscal 2Q17. Exabyte growth in 2017 was less than 30% due to industry-wide component constraints. However, WDC has seen a rise in demand for capacity enterprise drives towards the end of 2017 and has estimated the YoY industry-wide exabyte growth to exceed 60% in the first half of For the full year 2018, WDC estimates exabyte growth of over 50% driven by broad deployments of capacity enterprise drives.

9 What is driving infrastructure expansion? Mike C ordano, WDC C OO stated, Data center build out by several large hyperscale customers and guided industrial policies are driving significant global infrastructure expansion. This expansion has led to a growing demand for capacity enterprise drives in the mid-range and high-end range. WDC has a lower market share in the mid-range of capacity enterprise drives and has introduced new air-based products in the 4-TB (terabyte) and 5-TB segment. WDC expects the demand for high-range and mid-range capacity drives to support a higher rate of EB consumption this year. The firm expects an annual EB growth of 40% YoY in A Look at Western Digital s Revenue and Profit Margin Outlook Non-GAAP gross margin rose significantly in fiscal 2Q18 Western Digital s (WDC) non-gaap (generally accepted accounting principles) gross margin rose 655 basis points to 43.2% in fiscal 2Q18 driven by a favorable supply-demand environment for its flash-based products, cost improvements, and a higher mix of flash-based product revenue. Operating expenses rose 9% YoY (year-over-year) to $865 million driven by investments in product development and IT transformation projects. Operating expenses were higher than earlier estimated due to the company s over-achievement with regards to its six-month variable compensation plan. WDC continues to benefit from synergies related to the HGST and SanDisk integrations. The firm had achieved synergy targets outlined for 2017 and expects to benefit from these integrations over the next few years as well.

10 Revenue of $4.9 billion expected in fiscal 3Q18 WDC has estimated revenue of $4.9 billion in fiscal 3Q18 with gross margins between 42% and 43%. Operating expenses are expected to be in the range of $840 million and $850 million in the quarter ending March The firm expects EP S (earnings per share) between $3.20 and $3.30 in 3Q18 compared to EPS of $2.39 in 3Q17, indicating a YoY rise of 36%. WDC C FO Mark Long stated, We believe our integrated product and technology platform is a key differentiator that will enable strong long-term growth, profitability and value creation through industry cycles. Although revenue for the firm will be expected to be impacted by seasonality in the second half of fiscal 2018, WDC is optimistic it will achieve revenue growth at the high end of its projection of 4% to 8% this year. EPS for NetApp (NTAP), Seagate (STX), IBM (IBM), and Micron (MU) are estimated to rise 26%, 19%, 0.4%, and 105%, respectively, in their next fiscal years. How Is Western Digital Allocating Capital in Fiscal 2018? Free cash flow and capital expenditure In the previous part of this series, we have seen how Western Digital (WDC) is looking to improve profit margin and EP S (earnings per share). While the company continues to depend on its diversified portfolio of products to drive revenue, it is looking at other ways to improve shareholder value.

11 WDC generated $2.3 billion in operating cash flow at the end of fiscal 2Q18, a rise of 54% YoY (year-over-year). The firm deployed $915 million on capital investments resulting in a free cash flow of $1.4 billion. At the end of 2Q18, WDC reported cash, cash equivalents, and available for sales securities of $6.4 billion. These figures take the available liquidity to $7.9 billion. WDC repaid its euro term loan B and decreased its net debt by $500 million to $5.8 billion at the end of the quarter ending in December Dividend yield In fiscal 2Q18, WDC paid cash dividends totaling $148 million and declared a dividend of $0.50 per share, indicating an annualized payout of $2.00. WDC has a dividend yield of 2% and a payout ratio of 15.8%. In comparison, peer firms such as IBM (IBM), Seagate (STX), and NetApp (NTAP) have dividend yields of 3.8%, 4.3%, and 1.2%, respectively. WDC C FO Mark Long stated, We remain committed to the following capital allocation priorities. Organic and inorganic business investments deleveraging, optimizing our cost of capital and capital structure while enhancing our financial flexibility and delivering returns for our shareholders through our dividend and reauthorize share buyback program. Is WDC Trading at a Discount to Analyst Estimates in March 2018? Stock returns for WDC Western Digital (WDC) has returned 34% in the trailing 12 months, 23.5% in the last month, and 12.8% in the trailing five days. The stock rose 17% in 2016 and 20% in 2017, and it s risen 25% since the start of Peers Seagate (STX), IBM (IBM), and NetApp (NTAP) have returned 29%, -10%, and 55%, respectively, in the trailing 12 months.

12 Analyst recommendations Of the 31 analysts tracking WDC, 21 have recommended a buy, ten have recommended a hold, and none have recommended a sell. Analysts 12-month average price target for WDC is $ with a median target estimate of $115. WDC is now trading at a discount of 16% to analysts median estimate. Moving averages On March 9, WDC closed the trading day at $ Based on that price, the stock s moving averages are as follows: 16.3% below its 100-day moving average of $ % below its 50-day moving average of $ % below its 20-day moving average of $88.01 WDC is currently trading 40% above its 52-week low of $71.38 and 0.5% below its 52-week high of $100. Relative strength and moving average convergence divergence WDC s 14-day MACD (moving average convergence divergence) is A stock s MACD is the difference between its short-term and long-term moving averages. WDC s positive MAC D indicates an upward trading pattern. WDC has a 14-day RSI (relative strength index) score of 85, which shows that the stock is trading

13 well over oversold territory. An RSI is above 70, which indicates that a stock has been overbought, and an RSI figure below 30 suggests that a stock has been oversold.