Western Digital Earnings: $42 FVE Intact; Storage Market Recovery Begins and Flash Spinoff Announced

We maintain our $42 fair value estimate for no-moat Western Digital WDC after the firm reported a good first quarter and announced intentions to spin off of its flash chip business. We view the spinoff as value-neutral to shareholders as we don’t foresee any significant cost efficiencies gained as separate entities, but a cash infusion could help position the flash business for better growth. The market liked the announcement, and the stock is up about 6%. Western’s fiscal first-quarter results were positive, exceeding our expectations for revenue and profitability. Both HDD and flash markets showed signs of sequential improvement in the quarter, and management expects further gradual strengthening in the December quarter. We see shares as fairly valued.

September quarter sales declined 26% year over year and grew 3% sequentially, to reach $2.75 billion and hit the top end of previous guidance. Flash sales were strong, rising 13% sequentially to $1.56 billion, as shipments grew and prices were flat—a positive after several quarters of steep pricing declines. HDD revenue was down 41% year over year and 8% sequentially, due to a slow cloud recovery, driven in part by weakness at Chinese customers.

Non-GAAP gross margin was at the higher end of guidance at 4.1%, down from 26.7% a year ago and slightly up sequentially from 3.9%. Western incurred $225 million in underutilization expenses this quarter, roughly consistent with the June quarter. Management expects underutilization charges to improve through fiscal 2024, which should be a tailwind to gross margins.

Management expects December quarter revenue to be $2.95 billion at the midpoint and expects significant gross margin expansion sequentially. We are happy to see recovering results for Western, which we anticipate to be spread across both the HDD and flash businesses. We look for cloud shipments and flash pricing as the two primary drivers of a recovery that we expect to be drawn out through calendar 2024 and 2025.