Better Buy: Western Digital vs. Texas Instruments

Western Digital (WDC -2.64%) and Texas Instruments (TXN -1.23%) both produce essential components for myriad markets.

WD is one of the world's top producers of HDDs (hard disk drives), flash-based SSDs (solid-state drives), and flash memory chips. TI sells a wide range of analog and embedded chips for the automotive, industrial, consumer electronics, and communication infrastructure markets.

I compared these two stocks in late January, and declared that WD's sequential growth, lower valuation, and higher dividend yield made it a better buy than TI. But since then, WD's tumbled nearly 50% as TI's stock has risen about 6%.

Image source: Getty Images.

I was clearly wrong about WD, since I didn't expect the COVID-19 pandemic to derail its cyclical recovery and force it to suspend its dividend payments. I also underestimated TI's resilience and its appeal as a defensive stock. Therefore, let's take a fresh look at both stocks and see if TI will remain a stronger overall investment than WD.

COVID-19 ends WD's cyclical recovery

Last year, WD's revenue and earnings fell as it shipped few HDDs to PC makers and data center customers, and its SSD and NAND (flash memory) business struggled with low memory chip prices. However, WD's five-quarter streak of year-over-year revenue declines ended in the second quarter of 2020, and its top-line growth remained positive throughout the end of the year:

YOY = Year-over-year. Source: Western Digital.

During the first quarter, WD claimed its NAND business passed a "cyclical trough," and its disk drive sales to PC makers and data centers were stabilizing. Its growth over the following three quarters indicated it was on the cusp of a turnaround, but the COVID-19 pandemic, its dividend suspension in May, and its downbeat guidance in August all doused those hopes.

WD expects its first-quarter revenue to decline 3%-8% year-over-year, and for its adjusted EPS to grow 32%-91%. Those numbers aren't terrible, but they indicate WD's short-lived cyclical recovery is over. Analysts expect WD's pain to continue with a 6% revenue decline for the full year, but for tighter cost controls to lift its earnings 6%.

Texas Instruments clears a lower bar

Expectations for TI were already low before the pandemic hit, due to its anemic growth in automotive chips, declining chip sales to the enterprise market, and nearly flat chip sales to other markets last year. Its troubles continued in the first half of 2020, as the pandemic shut down auto plants, postponed communications network upgrades, and throttled its chip sales to most industrial markets:

YOY = Year-over-year. Source: Texas Instruments.

TI's second-quarter report featured a few bright spots -- including robust sales of personal electronics for the stay-at-home market and strong demand for new chips from the healthcare sector -- but those strengths couldn't offset the ongoing disruptions of automakers and non-healthcare industrial markets.

TI expects its revenue to decline 6%-14% year-over-year in the third quarter, and for its EPS to drop 10%-23%. It didn't provide any guidance for the full year, but analysts expect its revenue and earnings to decline 7% and 1%, respectively, before rebounding next year.

TI faces near-term headwinds, but it recently raised its dividend for the 17th straight year, and pays a decent forward yield of 2.9%. It also reduced its share count by nearly 50% since 2004, and plans to keep repurchasing shares throughout the crisis. Its gross margins are also holding steady, thanks to its cost-saving shift from 200mm to 300mm wafers, and its sales could rebound sharply after automakers come back online.

The valuations and verdict

WD trades at just nine times forward earnings, while TI has a much higher forward P/E ratio of 25. However, WD is cheap because its near-term outlook is unstable, its NAND business remains pinned to volatile market prices, and it no longer pays a dividend.

TI's stock is pricier, but investors seem willing to look past its near-term challenges and focus on its diversification and the post-pandemic growth of the auto and industrial markets. Until that happens, TI's dividends and buybacks should limit the stock's downside potential. I'm not in a rush to buy either stock right now, but the pandemic has clearly turned TI into a better all-around investment than WD.