While hard drives have been largely supplanted in the PC market by speedier solid-state drives (SSDs), the decades-old storage technology still has its place. In any application where data access times aren't all that important or where data needs to be stored for long periods, hard drives generally offer more bang for your buck.
The cloud-computing market is one area where hard drives are still widely used. Amazon Web Services (AWS), for example, offers its S3 cloud-storage product with a range of storage classes that help customers minimize costs. While Amazon doesn't disclose information on what hardware it uses, hard drives are almost certainly used for data that doesn't need to be accessed quickly.
Strong demand from cloud customers has helped offset declining consumer demand for hard-drive manufacturer Western Digital (WDC -2.64%), but the cloud market is now starting to show signs of weakness as well. U.S. cloud customers are cutting back drastically on component inventories, a sign that they're slowing growth and becoming more cautious.
Plunging hard-drive sales
Western Digital warned about this cloud hard-drive slowdown back in October when it reported its fiscal first-quarter results. Cloud revenue dropped 18% year over year for the company, but sales of capacity enterprise hard drives to U.S. customers were a bright spot. Revenue from cloud customers accounted for nearly half of Western Digital's revenue in the quarter.
With that bright spot fading as cloud-computing providers pull back on purchases, Western Digital is set for a tough year ahead. The company guided for Q2 revenue of $2.9 billion to $3.1 billion, well below the $3.7 billion reported in Q1. A combination of weak hard-drive demand and plunging demand and prices for solid-state drives will drive the decline.
A recent report from Trendfocus paints a dismal picture of the hard-drive market. According to the report, Western Digital shipped around 40% fewer hard drives in 2022 compared to 2021. Unit shipments don't tell the whole story, since high-capacity enterprise drives sell for a lot more than consumer drives. But Trendfocus pegged slumping demand from cloud companies for those enterprise drives as the biggest challenge facing the industry.
The impact of inventory corrections will eventually subside, which will improve the picture for Western Digital as its own shipments will more closely mirror end-market demand. But given the state of the economy and the potential for a drawn-out downturn, that process may take multiple quarters to play out.
The stock looks cheap, but it's not
Western Digital reported non-GAAP earnings per share of $8.22 in fiscal 2022, which would put the trailing price-to-earnings (P/E) ratio at less than 5. But earnings are set to collapse this year, and analysts may be overly optimistic about a recovery in 2024.
The average analyst estimate for non-GAAP earnings in fiscal 2023 is just $0.07, and the range of estimates is wide. There's a lot of uncertainty around demand for hard drives, and Western Digital's NAND memory and solid-state drive businesses are also facing major challenges. Analysts do expect earnings to rebound to $3.17 on average in fiscal 2024, which puts the forward P/E ratio at around 12.
That estimate for 2024 should probably be viewed as a best-case scenario. The hard-drive industry has been in decline for the past decade in terms of shipments, and while pricey enterprise drives are still in demand, the price advantage over solid-state drives has been fading. In the laptop market, solid-state drives have now reached similar prices as hard drives.
This isn't benefiting Western Digital's NAND memory and SSD businesses because prices and demand have been tumbling. According to TrendForce, NAND memory prices crashed as much as 25% sequentially in last year's Q4, and prices are set to drop another 10% to 15% in this year's Q1. As NAND memory gets cheaper, Western Digital's hard-drive business suffers. And because NAND memory is in severe oversupply, there's no real upside for the company in the short term.
Western Digital is set to report its fiscal Q2 results on Jan. 31. Investors should brace themselves for a rough outlook as the company navigates a tough environment.
