Shareholders of Western Digital (WDC) — which is a provider of storage systems and disk drives — got some disconcerting news today. Analysts from JPMorgan Chase dropped the rating on WDC stock from “overweight” to “neutral” and also slashed the price target from $105 to $92.
Then again, there has already been deterioration with WDC stock, which is off 19% for the year.
OK, so should investors continue to stay away? Or maybe there is a contrarian opportunity here?
Well, first of all, many Wall Street analysts still remain bullish on WDC stock. After all, Goldman Sachs recently upped its rating from a “neutral” to “buy” rating, with the price target going from $106 to $122.
Yet there are still some reasons to be concerned with WDC stock. Just take a look at the prior earnings report, in which CEO Stephen Milligan was fairly cautious.
His main worry? Of course, it’s the PC market, which appears to be languishing. And yes, a big part of this is the macroeconomic environment. Let’s face it, the world economy is coming under pressure, especially in China, South America and Russia.
As a result, the fiscal third-quarter results were lackluster for WDC as revenues fell by 4% to $3.5 billion, missing the Street consensus of $3.6 billion. Earnings were also a disappointment, coming to $1.9 per share. But this was down by 3 cents from what analysts were forecasting.
Now the good news is that over the years WDC has been moving beyond its core disk drive market. To this end, it has invested heavily in SSDs (solid-state drives), which are focused on the fast-growing categories of smartphones, tablets and other mobile devices.
In fact, in the latest quarter the year-over-year revenues shot up by 67% to $224 million.
WDC has also been making a strong move into the enterprise space, such as with its helium hard drives (which have eight terabytes of storage). Oh, and the company has been getting traction with its active archive system, which is a market that is estimated at $15 billion.
In terms of the financials, WDC is certainly in a solid position. During the latest quarter, the company cranked out $684 million in cash flows from operations. In all, the cash balance is about $4.8 billion.
What’s more, the valuation on WDC stock looks reasonable, trading at about 11 times forward earnings. The dividend yield is also at a decent 2.2%.
But all this may not be enough. Again, WDC relies heavily on PC demand. For the latest quarter, 32.3 million of the total 54.5 million shipments came from the PC side of the business.
Yet according IDC, the forecast is for PC shipments to fall by 6.2% in 2015. More importantly, there will be “limited growth” for the next few years as well. Actually, there have been two consecutive quarterly declines already.
Some of the factors include competition from mobile devices and tablets as well as the end of the upgrade cycle after the end of support for Microsoft’s (MSFT) Windows XP platform.
So given all this, it will be tough for WDC to get much traction with revenue growth — and this could last for a while. In other words, it looks like the analysts at JPM could be spot-on with its call.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
