Western Digital (NASDAQ:WDC) is impressive; it is the only company that actively operates in both storage markets: Hard Disk Drives ((HDDs)) and Solid State Drives ((SSDs)). The company’s hybridity makes it unique. It also means the WDC is juggling multiple balls. But no one can juggle forever without dropping a few balls here and there. WDC seems to be dropping balls at a regular cadence, which is reflected in its stock performance over the last few years. Despite having market shares in both businesses, WDC fails to dominate either sector. Studying the company’s prospects towards 2023, we give WDC a sell rating primarily because we believe the company has no significant tailwinds in the near term in both HDDs and SSDs.
More Global Data Translates To Heightened Storage Needs
Both HDD and SSD markets are forecasted to grow worldwide. HDD petabyte shipments are forecasted to grow 18.5% CAGR over 2020-2025. IDC is predicting SSD units to grow 7.8% over the same period. All signs show that storage demand is on the rise. What does this mean for Western Digital? Sadly, we do not think it means much. While the storage sector is growing, the WDC market shares in the storage sector are declining. The image demonstrates how WDC has lost market share to competitors, namely Seagate (STX), in HDD markets. Even in its stronger SSD market, WDC still shares the business with Samsung (005930), Kioxia, SK Hynix (000660), and Micron (MU), as shown in the charts. We are bearish on the stock because we think WDC will not play a significant role in HDD or SSD markets during 2H22. We believe investor money is better invested elsewhere in the golden age of data storage.
The Proof Is In The Pudding Or WDC’s Earnings
WDC’s recent earnings show the decline in the company’s HDD, NAND flash (SSD) revenue, and gross margin, as shown in the image below. We recognize that the HDD earnings will be more favorable into 2H22 due to the large capacity cloud demand. However, we do not believe it will move the needle on earnings much, given that WDC will likely experience a decline in demand from PCs.
We already see a decline in the HDD market, as highlighted in its 3Q22 earnings. We believe WDC is to blame for the drop in earnings. Suppose we shift focus to competitor Seagate 3Q22. In that case, we see higher revenue in HDD markets due to the company’s singular focus on large capacity disk drives geared towards Cloud Data Center. WDC lacks this focus and, in turn, has been facing declines over the past few years. We predict WDC’s growth will be moderate in the HDD market even during the current data storage boom. We advise selling the stock and redirecting investor money into better names such as Seagate (STX) for Hard Disk Drives and Micron (MU) for its focus on NAND/DRAM.
In terms of NAND flash earnings, we also acknowledge the market’s long-term growth as SSD takes over PC markets in addition to smartphones. But, again, we do not foresee this saving WDC from its downward trend. We believe WDC is a sell because it failed to achieve any form of oligarchy in the SSD market. Investing in WDC now is the equivalent of investing in a company with a bad track record and no operational vision to better itself.
WDC relies more on its SSD business after it purchased SanDisk in 2016. The 3Q22 quarterly fact sheet shows disappointing progress on HDD and SSD fronts. This only further affirms our sell rating. On a year/year basis, the shipments to clients and consumers declined while the cloud units were up. However, the Cloud unit’s outperformance was insufficient to overcome the total unit declines. Unit shipments of Flash and HDD in 3Q22 are lower than in the past three quarters, as shown in the slide.
We believe the market can expect more of the same from the company. Our concern about WDC’s coming quarters is also based on the downside risks within the market itself. We expect declines in desktops and notebooks and declines in mobile devices. We are not confident about WDC managing: unit declines in desktops and notebooks, increased focus on the HDD industry (not WDC’s strong suit), and higher costs for manufacturing NAND with lower revenue from NAND licensing. We recommend selling the stock because we do not think WDC is an attractive investment in the coming quarters.
Splitting Is Hard To Do; Pandemic Benefits Unwinding
WDC stock is discouraging. Over the last five years, Western Digital stock declined around 33%. We do not see any major catalyst for the company’s growth in the near term. However, the stock might see an initial bump up if the company agrees to split the company as urged by Elliot Management. However, splitting the company and untangling all the supply chains and go-to-market strategies will be time-consuming and distracting for the company. We would expect Western Digital quickly cede share to both HDD and NAND flash competitors as the company works to break itself into two pieces.
WDC benefited from the pandemic with the increased PC demands due to the shift to work-from-home environments. Yet, the stock still declined 12% over the past year. YTD, the stock is down around 7%, and we believe the downward trend will continue for the rest of 2022 until something dramatic happens with its structure.
We are optimistic about the future of data storage but not WDC’s role in it. Even if CEO Goeckeler follows through with the split at the urging of Elliott Management, we believe the stock will likely see an initial pop followed by a painful decline over time. WDC’s two components will face severe operational and technical challenges unwinding two businesses, which it painfully integrated after the acquisition of Sandisk. Therefore, we urge investors to sell at current levels before it creeps back to its fifty-two-week low of $44.We believe WDC has an unfavorable risk-reward situation and advise investors to put their money in more reliable picks.
We think WDC is pretty cheap compared to its semiconductor peer group, trading at around $60 per share. The fifty-two-week low is around $44, and even at its high, WDC did not exceed $78. WDC is trading cheaply at 1.1x EV/C2023 sales versus the peer group average of 4.5x. On a P/E basis, it is trading at 6.4x C2023 EPS of $9.27, versus the peer group average of 14.4x. We advise against buying the weakness. On a growth-adjusted basis, WDC is trading at 0.2, versus the peer group average of 0.7x. WDC is cheap by every metric. The following chart illustrates WDC’s peer group valuation.
Word On Wall Street:
Out of the 29 sell-side analysts, 17 are buy-rated, while 12 are hold rated. The median and mean price targets are $73 and $72, respectively. With Western Digital stock trading around $60, the upside is around 20-22% from the current levels. The following chart illustrates sell-side WDC ratings and price targets.
What To Do With The Stock:
We believe in the long-term growth of the storage sector. Nevertheless, we warn investors from buying WDC. We expect the stock will have limited outperformance potential through 2H22. We do not believe the company will have a rebound potential in the HDD or SSD market in the near future. In our opinion, WDC will remain a secondary player with an attractive price per share, but nothing more. We do not believe WDC provides an attractive risk-reward prospect. We recommend that investors stay clear of the company because it focuses on financial engineering rather than rebuilding its franchise and products to be the best in the industry.