Brutal Honesty From Western Digital

What will it take for Western Digital (NYSE: WDC  ) to get some market respect?

Last night's third-quarter report sent Western Digital's shares jumping for joy to the tune of 5% above the closing price. There was good reason for the positive reaction: The hard-drive maker exceeded every expectation with $0.96 of GAAP income per share on $2.48 billion in revenue.

But then management used the conference call to make a few guarded comments about the coming quarter -- there's some excess inventory floating around in the PC manufacturers' pipelines, and Western Digital expects a correction in the fourth quarter. That hurt. Shares are down 3% as of this writing, bouncing off a 4.3% floor at worst.

I'd understand this pattern if Western Digital was some growth phenom with highly inflated share prices and valuation. That was never the case. Along with sector rival Seagate Technology (Nasdaq: STX  ) , Western Digital has been a mouthwatering value play for a long time. The market expects SSD technology as presented by STEC (Nasdaq: STEC  ) and SanDisk (Nasdaq: SNDK  ) to make hard drives obsolete and unsellable, and it was a mature low-growth market with thin margins to begin with.

From where I sit, Western Digital's cautious market outlook is simply a responsible approach to take. I'd much rather invest in honest management teams than Pollyanna spin masters.

In addition, those hurtful outlook comments may have been a touch too conservative. Tablet computing should be digging impact craters into the hard-drive market because those laptop-replacement gadgets tend to ship with memory-based storage. But Wedbush Securities analyst Kaushik Roy dug into the improving gross margins at Western Digital and came up with a different conclusion: "Tablet cannibalization has not yet impacted them. The question is going forward what happens."

So Western Digital is an even deeper value today than it was yesterday. You can act on that knowledge as fellow Fool Jim Mueller did in his Rising Star portfolio a couple of weeks ago, or just add Western Digital to your Foolish watchlist to look out for further thinly motivated drops.

Fool contributor Anders Bylund doesn't hold a position in any of the companies discussed here. The 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. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


Read/Post Comments (3) | Recommend This Article (3)

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  • Report this Comment On January 19, 2011, at 3:44 PM, FoolSolo wrote:

    I can't remember how many times I've commented on this Fool site about WDC being so undervalued. As I have stated many times before, the so called "cannibalism" is way overblown, as is the whole iPad and tablet revolution. Fact is that tablets don't have a lot of storage, instead that storage is either on your home/office network, or on a cloud somewhere.

    Tablets are really a new entertainment platform, and will not displace PCs nearly as dramatically as the analysts are prone to conclude. Everyone I know who has an iPad, both in the office and at home, hasn't banished their PCs. In fact, many are adding network attached storage devices so they can access their data from their tablets and PCs or other devices such as X-box, Roku, and so on.

    Unfortunately WDC just doesn't get the respect it deserves, despite the fact that it literally dominates the consumer HDD market almost exclusively, and despite the astounding cash flow and cash reserves it has. WDC, along with Seagate have also been doing a little double dipping, releasing SSD devices of their own, and creating hybrid options that marry SSD with HDD technology.

    WDC's latest HDD technology puts 3-Terabytes in a single low-power drive, that is 3 Million Megabytes, for under $200 retail. SSD cannot compete with that, either on capacity or price per MB. Despite all these facts, WDC continues to be discounted. I'm not sure that will ever change because hype is abundant on Wall street, especially around iPad and Tablets.

  • Report this Comment On January 20, 2011, at 1:01 AM, LQM2 wrote:

    Astounding cash flow and reserves? True. But management is making it abudantly clear that shareholders aren't getting any.

  • Report this Comment On January 22, 2011, at 1:02 PM, FoolSolo wrote:

    @marknmpls

    I'm not sure what you mean. Management doesn't control the markets, or the analysts, they run a business, and it seems to me WDC management has been doing a pretty darn good job running the company.

    The market analysts and the market in general is discounting the stock. But it's hard to argue with the fact that WDC and STX have a duopoly in the HDD market. Clearly they've been doing something right, or they wouldn't have such a dominant position.

    Now, I suppose they could turn some of that cash into a dividend, but very few tech companies do as most will usually reinvest back into growing the business. Even a giant like AAPL doesn't have a dividend, so I suppose that makes them a poorly managed company.

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