Without question, the tech sector has been one of, if not the biggest standout in the market since COVID-19 brought the global economy to a screeching halt. After following the broad market indices into bear market territory, the entire sector, including the semiconductor industry, has staged a massive rally that now has a number of tech stocks near their pre-pandemic highs, or in a few cases, even above them.
The tech sector’s rally since mid-March has been fueled in no small measure by the shift of businesses in a variety of sectors from traditional office working models into remote, work-from-home arrangements. Innovative software and networking companies, for example, provide connectivity solutions including Virtual Private Networks (VPNs), video conferencing, and more that enable teams, departments and entire organizations to continue to work and collaborate together even at a distance, while hardware companies, including those in the semiconductor industry, have seen an increase in demand for the products that make those software solutions possible.
The products, services and technologies I’m talking about aren’t new; in fact, video conferencing, VPN’s and remote collaboration tools have been in place for years. The emergence of the global health crisis, however has put a bigger focus, and so also a bigger premium on these tools than ever before. That’s been positive news for stocks like Western Digital Corporation (WDC), who before the pandemic were struggling with pressures including memory and storage oversupply along with decreasing demand, especially in the PC business where a major portion of their revenues had been derived. The surge in work-from-home solutions has helped ease some of those pressures, which has certainly helped the stock price for WDC, which has rallied about 13% higher in the last month and nearly doubled from its bear market low in March at around $27.
Despite those positive developments, WDC’s fundamentals have remained under pressure, as free cash flow and cash and liquid assets have deteriorated over more than a year. In fact, the decline has been significant enough that as of the last quarter’s earnings report, management has suspended the stock’s dividend in an effort to save money. What does that mean for the stock’s value proposition? if the tech and semiconductor trend continues to be mostly favorable, does that mean WDC could be ready to turn a corner into greater profitability? If so, that might suggest the stock could still offer an interesting value; after all, even with the stock’s surge since March, it is still a little under -50% below its January high price at around $72 per share. Let’s dive in and take a look.
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 $14.6 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased by 633%, while revenue improved more than 13.5%. In the last quarter, earnings grew by almost 73%, while sales were slightly negative, -1.39%. The company’s margin profile is interesting, with indications of improvement; in the last twelve months, Net Income as a percentage of Revenues was -3.7%, but turned positive in the last quarter, at 0.41%.
Free Cash Flow: WDC’s free cash flow been declining for quite some time, and over the last twelve months was $351 million. It’s important to note 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 more than two years.
Debt/Equity: WDC’s debt to equity ratio is 1.01. The company’s balance sheet indicates for the time being, they have good liquidity; however, if Net Income continues to be negative, WDC could have trouble servicing the debt they have. As of the last quarter, cash was about $2.9 billion (versus $4 billion at the beginning of 2019) while long-term debt is about $9.3 billion.
Dividend: WDC does not currently pay a dividend, having suspended their dividend payout as of the last quarter.
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 $30.92 and translates to a Price/Book ratio of 1.49 at the stock’s current price. The stock’s historical average Price/Book ratio is 1.66, meaning that the stock is currently only about 12% below that average. That isn’t ideal from a value-oriented perspective, but could still be attractive under the right circumstances. A strong counter to that idea, however comes from the fact that the stock is also more than -50% above its historical Price/Cash Flow ratio. If you consider the two together, and factor in the fundamental red flags from declining Free Cash Flow and cash as well as Net Income, I think the signal is clear; WDC probably carries more downside fundamental risk right now than it does long-term, useful value,
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 drop from its pre-pandemic levels around $72 to its March low around $27. It also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. After rallying at the end of March and into early April to about the 38.2% retracement line around $44.50, the stock hovered between $44 and about $37 until mid-May. Since then the stock has picked up bullish momentum and is currently driving near to resistance at around $50 per share. A break above that level should give the stock momentum to push to around $55, where the 61.8% retracement line sits. Support is back at the 38.2% line, which is sitting right around $44.50. A drop below that point should see the stock find next support between $37 and $38 per share.
Near-term Keys: WDC’s declining fundamentals make any kind of long-term view of the stock hard to foresee anything but risk right now. That means that if you want to work with this stock, you need to focus on short-term opportunities. If the stock pushes above $50, consider buying the stock or working with call options, using $55 as a useful exit target. A drop below $44.50 could signal an attractive opportunity to short the stock or to buy put options, using $38 as an effective price to close a profitable bearish trade.