Western Digital Is Down But Not Out

Cory is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Feb. 1 Western Digital (NASDAQ: WDC) posted 4th quarter results that are hardly indicative of an industry in decline. Year over year net revenues rose 90% and unit shipments rose 108%. It is important to note that in 2011 the company’s manufacturing centers in Thailand were badly damaged due to the flooding there. That natural disaster lowered revenues and unit shipments for 2011, making subsequent gains somewhat more impressive than they ought to be.

Seagate Technology (NASDAQ: STX) also has factories in Thailand, but due to their location they were largely unaffected. Year over year, Seagate’s net revenues grew about 15%, and the company shipped 23% more units in the quarter ending Dec. 28, 2012. These are hardly the sort of numbers you would expect from an industry in freefall.

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It seems that “Death of the PC” fears have let Western Digital’s stock price diverge from it’s growing revenues.

An unimpressive shareholder appreciation record

Western Digital began offering a $0.25 dividend only three quarters ago. The company recently announced it will again distribute the same amount on April 15, 2013 to common shareholders on record as of March 29, 2013. Currently, that is a less than impressive 2.14% yield.

Adding to shareholder discontent is the company’s steady dilution of shares. Over the past decade Western Digital has steadily increased its number of shares outstanding from about 204 million in 2003 to 241 million at the end of 2012.

Western Digital’s main rival Seagate has been offering a dividend payment for nearly a decade. Although it failed to distribute a dividend for over a year between February 2009 and April 2011, Seagate has more than doubled its distribution since then to $0.38 per share, for a yield of about 4.5%.

Bright glimmers of hope on the horizon

Foolish blogger Chad Henage recently made a valid point about mobile device content and the limited storage space on those devices. While users might not be purchasing new PCs, external hard drives are a convenient way for users to back up the high definition videos created by their devices. As the number of mobile devices with HD cameras continues to rise, it stands to reason that demand for cheap and easy to use external drives made by Western Digital will rise as well.

Also as cloud-based storage needs rise, the enterprise market for cheaper traditional hard drives should rise as well. Western Digital’s subsidiary, HGST (the hard drive manufacturer formerly known as Hitachi Global Storage Technologies) is expected to release helium-filled hard drives later this year. The drives are intended to fill the needs of the enterprise market by running cooler and more efficiently.

Although Seagate has been the primary provider of digital storage in the enterprise market, Western Digital has been rapidly advancing on that front. Year on year, during the last half of 2012 the number of enterprise units shipped by Seagate didn’t budge from 13 million. Over the same period, Western Digital’s enterprise units shipped soared more than three-fold from 4.1 to 12.6 million. If the company’s highly anticipated helium drives deliver on their promise, I think we can expect its share of the market to rise even further.

Prices of solid state drives are rapidly declining

The cheapest solid state drive (SSD) I’ve heard of was recently unveiled by Micron Technology (NASDAQ: MU). The Crucial M500 SSD is the first terrabyte sized drive from Micron, and it is expected to retail at about $600. This new drive represents a huge reduction in price per gigabyte for SSDs. OCZ Technology also markets a 1 TB, 2.5 inch SSD called the Octane. The Octane's overall performance is comparable to Micron's new Crucial drive, but at several times the cost. The least expensive 1 TB Octane that I was able to find retails for about $2,500, more than 4 times the price of Micron's new drive.

The new Crucial drive from Micron is aptly named--the company hasn't been able to turn a profit in 6 straight quarters. Although the company's share price is well off it's it's 52 week low, it is currently trading at just a hair above tangible book value. Micron's new SSDs might crush the competition in the flash storage sector, but for price per gigabyte they still can't touch the value of a traditional hard drive. Fortunately for Western Digital, Micron's Crucial 1 TB drive is still 7-8 times the price of a traditional hard drive with the same capacity.

“Death of the PC” is still a looming threat

The proliferation of mobile devices without traditional hard drives is still high, and will remain the biggest threat to earnings growth at Western Digital. Rising demand for external hard drives and cloud storage might cushion the fall for this well-managed company, but the future of traditional hard drives isn’t looking too bright.

A strong balance sheet and indications of extreme value have me feeling bullish about this company. Western Digital is trading at about 1.3 times book value with an earnings yield of about 18 percent. That is, in my opinion, extremely undervalued, even for a company expecting a decline in revenues in the near term. Financially, the company is extremely well managed. Western Digital sports a current ratio above 2 and a debt to equity ratio of about 0.26. Despite the looming threat of mobile devices, I think Western Digital is a defensive value opportunity that is hard to pass up.

crenauer owns shares of Western Digital.. The Motley Fool owns shares of Western Digital.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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