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Is Western Digital a Buy?

By Anders Bylund - Updated Jun 3, 2019 at 4:56PM

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The hard-drive maker is about to bounce off the rock-bottom floor of a deep, dark cyclical downturn.

Data storage specialist Western Digital (WDC) is having a rough year on the public market. Share prices have plunged 57% in 52 weeks, including a 27% drop in May alone. Is Western Digital's business falling apart before our eyes, or would this be a great time to pick up shares on the cheap?

Let's have a look.

The latest news

Western Digital fell short of analyst expectations in each of its past two earnings reports. The second-quarter report in January came in just below the Street's projections on both the top and bottom lines. In the third-quarter report at the very end of April, the company delivered just one-third of the expected bottom-line earnings.

Third-quarter sales fell 27% year over year, landing roughly in line with analyst estimates at $3.67 billion. Adjusted earnings crashed all the way from $3.63 to $0.17 per share, well below the $0.46 consensus estimate. The dramatic underperformance was triggered by a $110 million writedown of unsold multi-chip flash storage devices that also contain DRAM components.

Without the inventory writedown, adjusted earnings would have landed at $0.54 per share. That would be a less painful crash and ahead of Wall Street's projections, but still an 85% year-over-year drop.

Close-up shot of a hard drive without its outer cover. Several lines of bright green ones and zeroes are rendered in circular patterns on the top platter.

Image source: Getty Images.

What's going wrong?

The global market for flash-powered SSD drives is expected to double in 2019 while traditional hard drives should boost their shipped storage capacity by about 30%, according to comments from Western Digital's management on the third-quarter earnings call.

That might sound like a bullish market forecast, but the capacity growth is counterbalanced by falling prices per gigabyte. The PC and smartphone markets are going through difficult times of their own, driven by Intel's (INTC) PC chip shortages, consumer apathy toward smartphone upgrades, and the ever-present storm cloud of the Chinese-American trade conflict. Therefore, even though Western Digital and other component makers are tapping the brakes on their production volumes, the supply and-demand equation is often tilting toward weak demand and oversupply.

Where will the turnaround start?

Western Digital's top brass expects end-market demand to catch a second wind in the back half of this calendar year.

All of that 30% bit growth in hard-drive demand should arrive in that period, preceded by flat year-over-year comparisons here in the first half of 2019. Smartphones should eventually build up a fresh head of steam as both phone makers and network operators start to introduce faster, more reliable 5G wireless connectivity across their product portfolios. And one of these days, the Chinese trade tension will go away and let computer component suppliers do business without paying tariffs on every border-crossing transaction.

These macro trends should help Western Digital clear out oversupplies throughout its distribution pipeline and start expanding its gross margin again.

Is Western Digital a buy today?

It's true that this company still faces serious speed bumps in the immediate road ahead. The demand-boosting market trends outlined above could take their sweet time to arrive, pushing Western Digital's recovery into 2020 and beyond.

That being said, the plunging share prices in recent months almost had to be an overreaction. Western Digital is now trading at just 9.5 times forward earnings and just barely above the company's total book value. In other words, market makers are acting as if Western Digital should just close up shop and liquidate all of its assets because that would create just as much shareholding value as actually continuing to run the business.

Frankly, that's just silly. Western Digital isn't going away anytime soon, and the macroeconomic headwinds that are keeping the company down right now won't blow forever. I can't promise that this is the very bottom of Western Digital's cyclical downturn, but I can tell you that the bounce -- whenever it happens -- should take this stock significantly above its current price.

Patience will pay dividends for Western Digital investors. Yes, the stock is a buy at these low prices.

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