Hard Disk Manufacturers Look Suspiciously Cheap

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Lately, the tech sector has rather fallen out of favor with investors, with the Computer Hardware industry especially hard hit as consumers are making the switch to mobile computing devices. One need only look at Dell’s dramatic decline to witness the strength of this trend. These developments have left the industry as a whole trading at relatively low multiples. However, some hardware manufacturers are trading at simply unreasonable valuations. Hard disk drive manufacturers for example appear to have been punished unfairly for the weakness in PC sales, which make some of them an enticing buy at the moment. Western Digital (NASDAQ: WDC) looks particularly appealing.

Stock Overview

Western Digital is one of the world’s largest producers of data storage devices. In fact, together with Seagate (NASDAQ: STX), these firms more or less have a duopoly in the industry after Seagate acquired Samsung’s HDD business and Western Digital acquired Hitachi’s, leaving the two firms with a combined market share of 87%. Western Digital has a market cap of nearly $11 billion, and its stock is up over 33% in the last twelve months. The stock yields about 2.2% and has a beta of 1.43.

Earnings and Balance Sheet

A cursory glance at WD’s earnings makes their low valuation surprising. EPS has beaten analysts convincingly every quarter last year, and moreover, it has been rising steadily since the end of 2011. Q4 2012 EPS beat by a huge 35%, full-year EPS coming it at $7.60. Q2 2013 earnings are due on January 23, with an EPS estimate of $1.81 and revenues of $3.65 billion, representing increases of about 20% and 83% respectively. WD has $2.13 billion of debt on the books, with a total debt to equity ratio of 26.5, but over 3.5 billion dollars’ worth of cash. With a levered free cash flow of $1.54 billion, the firm has a solid balance sheet. Competitor Seagate has a higher level of debt to equity and less cash on hand.

HDD Makers’ Peculiar Valuation

Few will contend at the moment that the makers of PC hardware are doing well, but the valuation of HDD makers seems just a little too low. Western Digital currently trades at 5.89x earnings with a forward P/E of 5.79x. Not only is this substantially lower than the industry average, but it is lower than Dell’s P/E of 8.74x. WD’s price to sales is only 0.80 and the price to book is 1.37. Seagate’s valuations are fairly similar, with a P/E of only 4.66 and a price to sales of 0.83. So what could explain these low multiples? According to some, investors simply don’t like the industry. Concerns of new technologies making traditional HDD’s redundant have left many investors wary, and the unpredictability of the industry’s margins are another concern. In the last five years, P/E multiples have been around these levels three times. Yet, while these are valid concerns, WD and its competitor Seagate seem a little too cheap to ignore at the moment.

Bottom Line

Hard Disk Drive manufacturers appear to be an industry that has been beaten down unreasonably hard in recent times, as they are still very profitable companies despite weakness in the PC sector. With valuations as low as they are, it is hard to ignore the potential upside these companies may have in store based on these multiples. At the moment, there are two dominant HDD manufacturers that are both trading at enticing levels, but WD seems like the better choice due to their strong balance sheet.

DUJames has no position in any stocks mentioned. 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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