Better Buy: Western Digital vs. Micron

Western Digital (WDC -0.37%) and Micron (MU 0.47%) both sell core components for PCs, servers, and mobile devices. WD is one of the world's top producers of HDDs (hard disk drives) and flash-based SSDs (solid state drives), and Micron is a leading vendor of DRAM and NAND (flash) memory chips.

Both companies struggled this year as the COVID-19 crisis disrupted supply chains, consumer sales of PCs, and enterprise demand for servers. That slowdown also disrupted the cyclical rebound in memory chip prices, which were expected to recover this year after stabilizing in late 2019.

As a result, WD's stock plunged nearly 50% this year as Micron's stock tumbled almost 20%. So is either tech stock worth buying after those steep declines?

Image source: Getty Images.

WD's turnaround abruptly ends

WD generated 52% of its revenue from flash-based SSDs and flash memory chips last quarter. The remaining 48% came from traditional platter-based HDDs.

WD splits its business into three main segments: client devices, which include drives for PCs, consumer electronics, embedded devices, and wafers; data center devices; and client solutions, which include its branded HDDs, SSDs, flash memory chips, and removable devices.

WD ranks third in the NAND market after Samsung and Kioxia, Toshiba's former memory chip unit. It ranks second in the HDD market after Seagate. WD's revenue and earnings declined throughout 2019 as it shipped fewer HDDs to PC makers and data center customers, and its flash business struggled with a supply glut and low market prices. But that five-quarter streak of revenue declines ended in the second quarter of 2020, sparking hopes for a cyclical recovery:

YOY = Year-over-year. Source: WD quarterly reports.

Unfortunately, WD expects its first-quarter revenue to decline 3-8% annually, well below expectations for 8% growth, and for its adjusted EPS to rise just 32%-91%, compared to expectations for 288% growth.

WD blamed that abrupt slowdown on the COVID-19 pandemic, and expects declining sales of its client devices (45% of its revenue last quarter) and data center devices (39% of its revenue) to wipe out higher sales of its client solutions (16% of its revenue). On the bright side, WD expects its adjusted gross margin to expand slightly year-over-year.

Micron still expects a cyclical recovery

Micron generated 66% of its revenue from DRAM memory chips and 31% of its revenue from NAND chips last quarter. The remaining sliver came from other types of memory chips. Micron is the third-largest maker of DRAM chips after Samsung and SK Hynix, and it ranks fourth in the NAND market after Western Digital. Micron generates its revenue from four main end markets: compute and networking (41% of its revenue last quarter), mobile (28%), storage (19%), and embedded solutions (12%).

All those segments, except for embedded solutions, grew annually last quarter and ended the company's six-quarter streak of annual revenue declines -- even after it lost Huawei's orders (12% of its 2019 revenue) amid the escalating trade war. However, cyclically lower DRAM and NAND prices still squeezed Micron's margins and profits:

YOY = Year-over-year. Source: Micron quarterly reports.

But Micron offered a rosier outlook for its fourth quarter, which overlaps WD's first quarter. It expects its revenue to rise 18%-28% annually, with a significant expansion in its adjusted gross margin, and for its adjusted earnings to jump 87%.

Micron attributes that recovery to stabilizing memory chip prices, accelerating demand in China's data center market, and remote work boosting demand for new notebook computers throughout the COVID-19 crisis.

Image source: Getty Images.

The valuations and verdict

Analysts expect WD's revenue to decline 6% this year, with just 6% earnings growth. But next year, its revenue could rise 15% as its earnings nearly double. Analysts expect Micron's revenue and earnings to decline 9% and 56%, respectively, this year. But in 2021, its revenue could grow 13% as its earnings rebound 54%.

Those longer-term forecasts point to cyclical recoveries for both companies, but investors should remain skeptical due to unresolved issues like COVID-19, the trade war, and the upcoming election.

WD and Micron both trade at about nine times forward earnings. Investors are clearly avoiding both stocks due to the near-term issues, but Micron is clearly the more appealing investment, for three reasons: It isn't hampered by a sluggish legacy HDD unit like Western Digital, its business has remained more resilient throughout the COVID-19 crisis, and it expects its cyclical recovery to continue as Western Digital's sputters out.