Rising Star Buy: Buying a Bigger Hard Drive

This article is part of our Rising Star Portfolios series.

It's been several months since I first purchased shares of hard disk drive maker Western Digital (NYSE: WDC  ) for my Messed-Up Expectations portfolio. In that write up, I highlighted that I'd be tracking shipments, revenue growth, and inventory pretty closely.

The latter was especially important, because Wall Street worried that there had been an inventory glut of hard disks, or HDDs for short. At the time, only one-third of sell-side analysts had a buy rating on Western Digital and its competitor, Seagate Technology (Nasdaq: STX  ) . SanDisk (Nasdaq: SNDK  ) wasn't well liked, either.

Today, the situation is much improved. The industry experienced a 4% sequential increase in HDD shipments in the most recent quarter -- compared to a historical seasonal pattern of a 1% or 2% decline -- and that was on top of a stronger-than-expected March quarter.

The inventory situation has improved, as well.

Inventory Category

7/1/09

7/2/10

Change

7/3/11

Change

Raw materials $97 $159 63.9% $172 8.2%
Work in progress $154 $255 65.6% $263 3.1%
Finished goods $125 $146 16.8% $142 (2.7%)
Revenue, full year $7,453 $9,850 32.2% $9,526 (3.3%)

Source: Capital IQ, a division of Standard & Poor's. Dollar amounts in millions.

A year ago, raw materials and work in progress had increased by more than 60%, while revenue grew by only 32%. That divergence indicated trouble for sales, since Western Digital wasn't pushing raw materials through to finished goods as quickly as before. In the meantime, finished goods didn't keep up with revenue growth, meaning the company was selling more goods than it made. The result: a glut of HDDs in customers' hands.

Over the past year, inventory growth has lined up much more with changes in revenue, indicating that the glut has largely worked itself through, and leaving Western Digital more aligned with the situation than before.

Wall Street has also changed its tune: Currently, 14 of 23 analysts have a "buy" or "outperform" recommendation on the company, while Seagate has 11 of 22 analysts making those calls.

Yet the stock price is lower today than it was at the beginning of the year. I believe that's because of macroeconomic concerns about future storage-space buying habits, rather than company-specific unease. And since I believe that there will always be something to worry about, I don't let macroeconomic fears dictate my fundamental way of investing. When the market hates stocks, that's your best time to buy them.

Tomorrow, the MUE port will expand its position in Western Digital.

After you add Western Digital to My Watchlist, come and discuss the investment on my Messed-Up Expectations discussion board, or follow me on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Fool analyst Jim Mueller doesn't own shares of any company mentioned. He's an analyst for the Motley Fool Stock Advisor newsletter service.

The Motley Fool owns shares of Western Digital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never messed up.


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