AI Data Cycle Recovery Will Drive Storage Demand For Flash And HDD

Key Takeaways

• Separating Flash and HDD businesses is expected to unlock shareholder value and create two entities better positioned for market opportunities.
  
• Robust growth in the HDD business, driven by high-capacity drives and technology, is expected to enhance revenue and net margins.
  
• Western Digital faces profitability challenges due to pricing pressure, oversupply, operational risks, and inventory demand visibility in its Flash and HDD segments.

Catalysts

Develops, manufactures, and sells data storage devices and solutions in the United States, China, Hong Kong, Europe, the Middle East, Africa, rest of Asia, and internationally.

• The separation of Western Digital's Flash and HDD businesses is expected to unlock significant shareholder value, creating two stand-alone entities better positioned to capture market opportunities, potentially impacting earnings positively.
  
• Western Digital's HDD business is experiencing robust growth driven by high-capacity enterprise drives and UltraSMR technology, which are expected to maintain revenue growth and improve net margins through increased adoption and pricing power.
  
• The strategic focus on optimizing production levels in response to inventory adjustments in the Flash segment is aimed at stabilizing profitability, which could improve net margins as the market recovers.
  
• The anticipated recovery in storage demand from the AI data cycle, particularly in the data center space, is expected to drive revenue growth for both Flash and HDD businesses.
  
• Western Digital's focus on operational excellence and efficient cost structure in the HDD business is likely to improve gross margins, contributing to stronger earnings and sustainable profitable growth.

Western Digital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Western Digital's revenue will decrease by 14.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 7.8% today to 13.9% in 3 years time.
• Analysts expect earnings to reach $1.4 billion (and earnings per share of $4.51) by about April 2028, up from $1.2 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $1.6 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 25.8x on those 2028 earnings, up from 10.2x today. This future PE is greater than the current PE for the US Tech industry at 12.1x.
• Analysts expect the number of shares outstanding to grow by 6.52% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.46%, as per the Simply Wall St company report.

Western Digital Future Earnings Per Share Growth

Risks

• The Flash segment of Western Digital is experiencing temporary headwinds due to pricing pressure caused by increased utilization rates and customers working down inventory, impacting gross margins and earnings.
  
• Western Digital's Flash business faces challenges from pricing headwinds and oversupply in the broader NAND market, likely leading to a decline in profitability in the near term, affecting net margins.
  
• The separation of the Flash and HDD businesses introduces risks related to operational execution and potential dis-synergies, which could increase operating expenses and impact net earnings.
  
• Underutilization charges in the Flash segment, as a response to oversupply, indicate potential inefficiencies and increased costs, negatively affecting gross margins and overall profitability.
  
• Visibility into future customer demand and inventory levels remains a concern, particularly in the HDD segment, where supply tightness could lead to fluctuating shipment volumes, impacting revenue consistency.

Valuation

• The analysts have a consensus price target of $64.016 for Western Digital based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $100.0, and the most bearish reporting a price target of just $38.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $9.8 billion, earnings will come to $1.4 billion, and it would be trading on a PE ratio of 25.8x, assuming you use a discount rate of 9.5%.
• Given the current share price of $35.62, the analyst price target of $64.02 is 44.4% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.