One of the most volatile industries in the American economy over the year – and perhaps the most sensitive to trade tensions and intrigue – has to be the Semiconductor industry. Semiconductor companies make up the backbone of the entire Technology sector, since this is the industry that produces everything that makes modern computing possible. From memory components including system memory and long-term storage to wireless communication to CPU’s, you can think of semiconductors quite literally as the “guts” of the computing world.
One of the main contentions the Trump administration has used as a focal point to justify the trade war between the U.S. and China – intellectual property protection – relates directly to this industry. Friday seemed to offer perhaps the first real glimmer of hope since the beginning of trade tensions and tit-for-tat tariffs in early 2018, as both sides agreed to a cease fire that halted an increase of tariffs from the U.S. that was scheduled to take effect this Tuesday. Whether or not it leads to a more comprehensive agreement and ultimate compromise of the trade war remains to be seen; but it certainly does mark the first bit of useful, positive news about trade trade in a long time.
The market has operated for practically all of 2019 on the expectation that a deal is ultimately going to be reached, and so it’s been aggressive about pricing any hint of progress, no matter how small or realistic into stock prices. That has included stocks in the Semiconductor industry.
Western Digital Corporation (WDC) is a good example of a semiconductor stock that bore the brunt of market sentiment against the semiconductor sector in 2018 but has rebounded strongly in 2019. From a low price at the beginning of the year at around $34, the stock has rebounded strongly, hitting its highest point in a year last month at around $65 per share. From that point, the stock has retraced a bit, dropped to its current price a little below $59, but appears to be setting up a good, bullish ABC retracement pattern that could provide momentum to continue the upward trend that is now almost ten months long.
It’s reasonable to suggest that continued progress on the trade front will probably act as a catalyst for the broad market, at least on a temporary basis. That means that semiconductor stocks are likely to be among the biggest beneficiaries; that puts WDC among some of the leaders in the industry that could see its stock prices reclaim the highs they last saw in early 2018 before the trade war began in earnest. The real question, if you prefer to take value-oriented approach to finding good opportunities, is whether WDC also has the fundamental strength and value proposition to support a long-term move to those highs, or is such a move strictly subject to the whims of market sentiment?
Fundamental and Value Profile
Western Digital Corporation (Western Digital) is a developer, manufacturer and provider of data storage devices and solutions that address the needs of the information technology (IT) industry and the infrastructure that enables the proliferation of data in virtually every industry. The Company’s portfolio of offerings addresses three categories: Datacenter Devices and Solutions (capacity and performance enterprise hard disk drives (HDDs), enterprise solid state drives (SSDs), datacenter software and system solutions); Client Devices (mobile, desktop, gaming and digital video hard drives, client SSDs, embedded products and wafers), and Client Solutions (removable products, hard drive content solutions and flash content solutions). The Company develops and manufactures a portion of the recording heads and magnetic media used in its hard drive products. WDC has a current market cap of about $17.3 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined by -100%, while revenue declined almost -29%. That pattern improved in the last quarter, where earnings increased by 100%, while sales were mostly flat, but negative at -1.09%. Additionally, the company’s margin profile is a major red flag; the company’s Net Income has been negative over the last twelve months as well as the last quarter. This is a strong indication of the negative effect trade has had on the company, along with broad industry pressures on memory and storage products that has kept prices and revenues down over the past year.
Free Cash Flow: WDC’s free cash flow is generally healthy, but also declining, at $790 million over the last twelve months. It’s important to not that at the beginning of 2018, Free Cash Flow was around $3.5 billion; this is a good reflection of the pressures that the company has been dealing with for almost two years.
Debt/Equity: WDC’s debt to equity ratio is 1.03. The company’s balance sheet indicates that while operating profits are inadequate to cover short-term needs, they retain sufficient flexibility from cash and liquid assets to service the debt they have. As of the last quarter, cash was about $3.45 billion while long-term debt is about $10.7 billion.
Dividend: WDC’s annual divided is $2.00 per share, which translates to a yield of 3.43% at the stock’s current price.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for WDC is $34.02 and translates to a Price/Book ratio of 1.71 at the stock’s current price. The stock’s historical average Price/Book ratio is 1.82, meaning that the stock is currently only about 6% below that average. That puts a long-term target price for the stock at around $62 per share. That isn’t very encouraging from a value-oriented perspective; however the stock is also about 19% below its historical Price/Cash Flow average, which provides a long-term target at around $69,
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s downward trend from $107 in March 2018 until the end of December when it bottomed around $34; it also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock has rallied nearly 58% from that low point. In September, the stock hit resistance around the 38.2% Fibonacci retracement line around $64 before dropping back almost -10% from that point. The stock appears to be sitting right on support at around $56 per share. A push above $64 could give the stock to keep increasing in value to about $70 where the 50% retracement line rests, while a drop below $57 per share could see the stock find its next support level at around $50 per share based on previous pivot levels in August.
Near-term Keys: WDC is a stock that needs to show some signs of reversing its negative Net Income pattern and deteriorating Free Cash Flow before I think any real kind of argument can be made that the stock should be higher than it is right now. That means that if the stock’s current bullish momentum does continue, it’s really going to be tied more to market sentiment than any other single factor. While that doesn’t offer a lot of optimism for a long-term opportunity, there could be interesting short-term opportunities depending on the stock’s price action within the next few weeks. A push above $64 could be a good signal to buy the stock or work with call options, with a short-term target at around $70 per share, while a drop below $57 would be a strong indication to short the stock or to work with put options.