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Why I'm Buying More Western Digital

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This article is part of our real-money portfolios series.

When I first purchased shares of Western Digital (NYSE: WDC  ) for my Messed-Up Expectations portfolio, the inventory situation for hard disk drives was a worrisome point for analysts, as there seemed to be too much. Not only that, but growth was expected to be not very good.

Today, however, the situation is quite a bit different. First, last fall there was massive flooding in Thailand, where most of the world's HDDs are made, which has led to the situation where the inventory supply is seemingly too low. (The situation is much improved, but still not back to normal.) Not only that, but HDD demand is expected to remain high thanks to more media content, cloud storage, and corporate data floating around, not to mention demand to be driven by Microsoft's newest Windows operating system.

Plus, instead of five major competitors in the industry, there remain only three after Seagate Technology's (NYSE: STX  ) purchase of the HDD business of Samsung late last year and Western Digital's spring purchase of the Global Storage Technologies division of Hitachi (called HGST). By the latest estimates from IHS iSuppli, this gives Western Digital about 45% of the market, while Seagate has about 42%, leaving about 13% for Toshiba.

So here's the situation:

  • Today's Western Digital is the largest player in an oligopolistic industry.
  • HDD demand is climbing and prices are not expected to come down soon (IHS points out the pricing power Western Digital and Seagate currently enjoy).
  • The flooding damage in Thailand is almost entirely fixed and production is ramping back up.
  • The company is going through a smooth CEO transition as John Coyne will retire at the beginning of 2013 and industry veteran (and former Western Digital executive) Steve Milligan will take over.
  • Western Digital's CFO says that the company can produce well over $2 billion a year in free cash flow.
  • Yet the current price indicates that the market thinks Western Digital shouldn't be producing more than about $1.6 billion of FCF a year and never grow from there. (For reference, the company produced over $2.4 billion in FCF over the past four quarters, three of which came before the merger with HGST.)

Seems to me that the market isn't accurately pricing in the long-term prospects of this company, a situation I call a messed-up expectation.

Over the past year and a half, I've purchased Western Digital three times, with each purchase solidly in the green and soundly beating the market. I'm going to be adding to this winner.

Come and discuss these and other investments on my Messed-Up Expectations discussion board, or follow me on Twitter.

While I happen to like Western Digital as a HDD manufacturing company, there are three companies that are set to take over technology and revamp how we manufacture everything. They could disrupt the production of everything from machine parts to prosthetics. Click here to find out what they are and what they're doing that's so exciting.

This article is part of our real-money 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 analysts (and their portfolios).

Fool analyst Jim Mueller doesn't own shares of any company mentioned. He's an analyst for Motley Fool Stock Advisor. The Motley Fool owns shares of Western Digital and Microsoft. Motley Fool newsletter services have recommended buying shares of Microsoft and have recommended creating a synthetic covered call position in Microsoft. 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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Jim Mueller

Jim is a Senior Analyst for Stock Advisor and Motley Fool Options, and is the portfolio lead for the Phoenix 1 portfolio of Supernova.

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