"No, there's no making sense of it
Every way I go I'm bound to lose
Too much love will kill you
Just as sure as none at all"
-- "Too Much Love Will Kill You" by Brian May, 1992
This tribute to the rapidly waning National Poetry Month seems like a perfect fit for Western Digital (NYSE: WDC ) today.
The maker of hard drives for enterprise and consumer systems just reported third-quarter results, and it was a blowout. Non-GAAP earnings jumped 281% year over year to $2.52 per share on $3.0 billion in sales -- a 30% boost. Analysts would have settled for something like $1.55 per share on the bottom line and a 7% revenue boost.
Moreover, Western Digital is so over the flooding disaster in Thailand. "The recovery activities related to both WD operations and those of our supply chain partners affected by the Thailand floods have reached a point where we now have the capability to adequately meet anticipated customer demand in the current quarter and beyond," said CEO John Coyne.
And therein lies the rub. WD's quick recovery is killing the stock, which dropped as much as 15% on the news. Not exactly the kind of reaction you'd expect from earnings like that, right? In all fairness, archnemesis Seagate Technology (Nasdaq: STX ) shareholders are feeling the pain, too: Seagate plunged 10% at worst.
So why is a full recovery so bad for hard-drive stocks? In very simplistic terms, the disaster hamstrung hard-drive production and drove up prices significantly. With supply and demand in balance once again, investors fear that drive prices might plummet -- taking revenue and profit boosts with them. Just look at this pricing trend and tell me what happens when average unit prices snap back to normal levels:
|Average Selling Price
|Unit Volume (Millions)
Data taken from Western Digital's earnings calls as presented by S&P Capital IQ.
Put your Foolish thinking cap on
How should we Fools think about Western Digital's update? For one thing, these comments run counter to Seagate's more muted recovery outlook. In Seagate's view, it will take another year or so to repair the capacity gap across the computing industry's food chains. System builders, distributors, and other customers still need to rebuild their depleted inventories even after manufacturing plants get back to full speed.
And I think Western Digital agrees with that thinking. The outlook for the second quarter points to sales in the $4.3 billion range and earnings close to $2.45 per share. The year-ago quarter -- pre-flooding -- stopped at $2.4 billion and $0.81 per share, respectively. That surge comes even as the expected unit volume fell somewhat year over year.
Coyne underscores that conclusion: "There's still a little bit of catch up to do." My math also agrees as the stable revenue and earnings guidance figures imply that pricing should stay pretty flat at last through the summer. If you picture unit prices plunging while volumes ramp up, you might still see similar top-line sales, but profits would suffer.
It's like the difference between Apple (Nasdaq: AAPL ) and Wal-Mart (NYSE: WMT ) : Apple collects huge revenue from a relatively small number of pricey transactions, while Wal-Mart turns over untold billions of transactions at much lower prices and sliver-thin profit margins. That's why Wal-Mart handles triple the revenue of Apple but Cupertino walks home with the larger profits and cash flows.
If Apple's margins ever start looking like the retailing giant's, profits would plunge. That's what investors imagine happening to Western Digital and Seagate very soon. But even a fully functional supply chain will need to run red-hot to plug the lingering unfilled demand -- and don't forget the holiday and back-to-school seasons boosting demand in the back half of the calendar year. I still see strong pricing lasting at least until the holidays, maybe even into 2013.
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