Foolish Forecast: Make Room for Western Digital

On Thursday night, we'll get a first-quarter 2008 report from hard drive designer Western Digital (NYSE: WDC  ) . This is a downtrodden stock in a hot sector, so this Fool thought you'd like to see how the storage business led into this report.

What Fools say:
Here's how Western Digital's CAPS score rates against some of its peers and competitors:

Market Cap (millions)

Trailing P/E Ratio

CAPS Rating (out of 5)

EMC (NYSE:EMC)

$52,830.0

35.4

*****

Hitachi (NYSE:HIT)

$22,080.0

N/A

**

Seagate Technology (NYSE:STX)

$14,620.0

12.6

****

Western Digital

$5,520.0

10.1

****

Quantum (NYSE:QTM)

$731.6

N/A

***

Data from Motley Fool CAPS as of Oct. 31.

If you can run a profitable storage business, it seems that CAPS players will like you, and Western Digital certainly qualifies on that point.

One All-Star player points to an "undeserved low price here," saying that the company "will outperform by reversing to fair price." Another bullish CAPSer says it is an "awesome company" with a promising product-development pipeline. Nobody has made a negative comment since March, and there is just one thumbs-down grade among the last 165 ratings entered.

What management says:
WD upped its earnings and revenue guidance in September, and now expects $0.61 to $0.65 of net profit per share on $1.6 billion to $1.65 billion in sales. The brighter outlook was based on "improvements in demand, product mix and pricing."

What management does:
There's steady and ample sales growth going on, and the profit margins have an agreeable habit of stepping up a bit every now and then. That leads to generous earnings growth.

If you assume that Western Digital can keep up at least 20% earnings growth for the foreseeable future and add in a P/E ratio around 10 times trailing earnings, then you get a PEG number in the Dirt Cheap range. Yes, that's a technical term.

Margins

3/2006

6/2006

9/2006

12/2006

3/2007

6/2007

Gross

18.7%

19.1%

18.9%

18.2%

17.3%

16.5%

Operating

7.8%

8.5%

8.6%

8.3%

8.3%

7.6%

Net

7.5%

9.1%

9.3%

9.2%

9.1%

10.3%

FCF/Revenue

2.4%

2.3%

3.6%

3.6%

4.9%

5.4%

Growth (YOY)

3/2006

6/2006

9/2006

12/2006

3/2007

6/2007

Revenue

21.7%

19.3%

20.1%

23.0%

23.6%

26.0%

Earnings

68.0%

101.5%

82.7%

60.2%

50.3%

42.8%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
It's hard to find fault with results like these, especially at such a low valuation. Running the numbers through a discounted cash flow calculator (available to Inside Value members -- take it for a free 30-day test drive) with a conservative 20% growth target shows that the stock may be 40% undervalued today. Simple P/E figures point in the same direction.

It's no wonder my fellow Fools like to highlight Western Digital in deep-discount roundups, or recommend that you give this stock to Mom on Mother's Day. I thought it looked cheap back in January, and the stock has nearly tripled the returns of the S&P 500 benchmark since then -- but it still has plenty of room to improve. Is this the report that will restore Western Digital to its rightful valuation? Shareholders certainly hope so; the rest of us want some more time to buy in.


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