Tuesday, May 12, 2009

Western Digital. After a big run, not quite as cheap.

I wrote the following in November 2008, and will take another look at WDC after this run-up.

Western Digital's (WDC) FCF yield for 2008 is nearly 25%, which is why I bought shares recently. Price-to-Sales of .4 neglects the $500m of net cash, and the trailing PE is 3.8.
It’s an exercise in futility to argue for higher PE multiples for WDC or other storage companies, so I won’t do it.

Worries about flash encroaching upon or destroying the market for WDC’s products are legitimate but overstated. Just over a year ago, Kevin Hunt of TWP described the thinking of the flash executives at IDEMA DiskCon: “They seem to really believe that a $1,000 premium for one-third the storage capacity on an $800 notebook is a great deal.”
Flash drives use less power and are smaller and lighter than disk drives, but are many times more expensive. WDC should still have running room as the greatest global PC growth is in developing markets, where demand is for cheaper PCs and notebooks, making flash prohibitively expensive. By the time competition from solid-state drives becomes a mortal threat, a buyer of WDC would’ve reaped well over the purchase price in free cash flow. The company’s heavy CAPEX spending (50% higher than D&A currently) will enable it to introduce new products to offset (and potentially reverse) ASP declines.

In May 2007, Barron’s touted WDC when the stock was at 18 and expected EPS was 1.92. Now the stock is at 16.50 and EPS estimates at 3.41. I think that the stock could return to 30 soon.

So now at 22.50, the stock trades at a MUCH more respectable 11 times forward '09 and '10 estimates, which should come in around 50% lower than the 4.31 earned last year. Based on conservative guidance from management, WDC looks to be trading at a 13-15% FCFY (free cash flow yield on "net of cash" MCAP) - not bad, but in this market one needs to be picky - I'd buy it closer to 18-19.

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