Western Digital Overview

March 7, 2005 - Copyright by Morris Rosenthal - - contact info

Trading Notes

DELL
HPQ (Hewlett Packard)
INTC (Intel)
AMD (Advanced Micro Devices)
MU (Micron)
NVDA (Nvidia)
ATYT (ATI Technologies)
WDC (Western Digital)
IOM (Iomega)

Notes on trading WDC stock for investing in my SEP

Western Digital is a pure play hard drive maker. Hard drives used to mean exclusively computers and storage arrays, these day's they are used in multimedia devices such as TIVO's and even some personal music players. At some point in the future, hard drives will probably be replaced entirely by semiconductor memory of the flash flavor, but currently, the economics still favor the mechanical solution. Western Digital did a bit of investing in the past year, paying just under $100 million on the acquisition costs for Read-Rite, which means they are now making the r/w heads for their own products, though they still buy the other components on the open market. While that may protect them from certain market fluctuations, it also means they have to carry the R&D and capital expenditures to keep the head business relevant. Like so many other companies, they are buying back their own shares, with $100 million authorized in the past year. Amongst the positive things you can say about WD are their relatively low P/E, at just over 15, and decent debt/equity ration, about the same as HP.

WDC has appreciable options overhang and they dedicate a few pages of their quarterly reports to explaining the situation. I don't follow all the ins-and-outs, but it looks to me like options and employee stock compensation cost the company over 10% of their net income last quarter. Gross margins were down a little over a point on a year-to-year comparison, due to competitive pricing pressure. When margins are in the mid teens to start with, that's worrisome. R&D costs at just under $60 million for the quarter were running about double the marketing and general admin budget, and were up over 35% from the previous year quarter. WDC does their manufacturing in Thailand and Malaysia, which means cheap labor and high geopolitical risk. However, they seem to have operations well in hand, because as I read the 10K report, their negative cash conversion cycle means they are getting finished products out the door a couple days before they have to pay for the materials that go into those products! Their biggest risk is probably that hard drive prices go back into free-fall, instead of just steadily eroding margins.

Western Digital has been trading up recently because of increased earning, at the current record level for the year. Shareholder equity is given at about 20% of the market cap. Insiders have been selling WDC pretty steadily for the last, most of thenm probably have options in the money. It hasn't stopped institutions from loading buying the stock, currently around 65% of WDC shares are held by institutional investors and mutual funds. I believe WDC was the first individual stock I ever owned, got in around $3.50 and sold a little over $5. Too bad I didn't drop my whole net worth in there and sit tight until today.

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