Separation Will Enable Focus Amid Rising AI Data Storage Needs

Key Takeaways

• The separation of Flash and HDD businesses aims to enhance focus, agility, and financial performance, potentially boosting net margins and earnings.
  
• Growing demand for AI-driven data storage and UltraSMR technology advances are expected to drive substantial revenue and margin growth.
  
• The separation of Western Digital's businesses and market pressures introduce risks that could impact revenue, margins, and debt management amid competitive and economic challenges.

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.

• Western Digital's upcoming separation of its Flash and HDD businesses could unlock value by allowing each entity to be more focused and agile. This separation is expected to improve operational efficiencies, enhance structural margin potential, and result in better financial performance for both entities, impacting net margins and earnings.
  
• The growing demand for AI-driven data storage is creating substantial growth opportunities for Western Digital. The AI data cycle is expected to increase long-term storage needs, fostering revenue growth particularly in the Flash and HDD markets.
  
• The introduction and adoption of Western Digital's UltraSMR technology in HDDs are expected to drive revenue growth and margin expansion, as the company launches high-capacity drives that address the demand for scalable and cost-effective storage solutions, impacting gross margins and profitability.
  
• The ramp-up and increasing mix of enterprise SSD offerings, particularly for AI and data center applications, are projected to drive significant revenue growth in the Flash segment. As demand for these higher-margin SSD products grows, it is expected to have a positive impact on gross margins and overall earnings.
  
• Western Digital's strategic focus on maintaining a balanced supply-demand dynamic and on improved visibility into customer needs is expected to support more predictable business operations and sustainable profitable growth, improving operational efficiencies and net margins over the long term.

Western Digital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Western Digital's revenue will grow by 9.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 2.3% today to 9.2% in 3 years time.
• Analysts expect earnings to reach $1.7 billion (and earnings per share of $4.74) by about December 2027, up from $329.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $2.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 23.9x on those 2027 earnings, down from 67.9x today. This future PE is lower than the current PE for the US Tech industry at 26.8x.
• Analysts expect the number of shares outstanding to grow by 1.91% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.16%, as per the Simply Wall St company report.

Western Digital Future Earnings Per Share Growth

Risks

• The ongoing separation of Western Digital's Flash and HDD businesses introduces risks related to execution and regulatory approvals, which could lead to increased costs and disrupt operational efficiencies, potentially impacting revenue and net margins.
  
• The financial health of the company is exposed to potential economic downturns in consumer and client markets, as observed in the weakness in PC OEM and smartphone markets, which could adversely affect revenue.
  
• Western Digital's debt levels, with $7.5 billion in gross debt and contingent liabilities from tax repatriation and settlement payments, could pressure future earnings if operating cash flow remains insufficient to cover these obligations.
  
• The reliance on large cloud customers and potential volatility in demand from these hyperscalers could lead to unpredictable revenue streams, particularly in the context of increased HDD and SMR product shipments.
  
• While investments in technology and enhanced product offerings position the company for growth, intensified competition in the enterprise SSD space could pressure pricing and margins, challenging profit growth.

Valuation

• The analysts have a consensus price target of $89.81 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 $115.0, and the most bearish reporting a price target of just $60.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $18.8 billion, earnings will come to $1.7 billion, and it would be trading on a PE ratio of 23.9x, assuming you use a discount rate of 8.2%.
• Given the current share price of $64.64, the analyst's price target of $89.81 is 28.0% 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.