Why Lower Memory Prices Will Hit Western Digital Corp Stock Hard

NAND memory prices have started falling, and so will WDC stock

By Will Healy, InvestorPlace Contributor


Western Digital Corp (NASDAQ:WDC) took a hit Monday. WDC stock had just recovered from a high-profile legal battle. Now, Morgan Stanley released a report that the “super-cycle” in chip prices might be winding down. Not all agree that the cycle has yet ended. However, with the profit margins on NAND memory now in question, investors are likely better off avoiding WDC stock.

Why Lower Memory Prices Will Hit WDC Stock Hard
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NAND Memory Affects All WDC Divisions

WDC serves as a developer, manufacturer, and provider of data-storage devices and solutions. The company consists of three divisions: Datacenter Devices and Solutions, Client Devices, and Client Solutions.

The Datacenter division focuses on enterprise storage solutions. Client Devices emphasizes desktop, mobile and gaming applications. Client Solutions consists of external and removable products. All three divisions rely on the NAND memory chips that had been heavily in demand until recently.

Moreover, profitability prospects still looked promising with the most recent Q1 2018 earnings report in late October. Both revenue and earnings came in ahead of expectations.

The company reported $40 million more in revenue than was expected at over $5.18 billion. Earnings for the quarter stood at $3.56 per share. This figure was 26 cents per share higher than expectations. It represented a 43% increase over 1Q 2017 earnings.

At the time of the report, analysts had been guiding for a 2018 consensus earnings average of over $12 per share in 2018. At the current stock price, that places the forward PE ratio at just over 7. The company had expected NAND memory pricing to remain strong for the next year.

The report from Morgan Stanley (NYSE:MS) stopped WDC stock in its tracks. The firm cut its rating on WDC stock from “Overweight” to “Equal Weight.” It also cut the price target for the WDC stock price from $117 to $90 per share.

Other chip stocks have been affected as well. Samsung Electronics Co Ltd (OTCMKTS:SSNLF) experienced its largest drop in over a year. Micron Technology, Inc. (NASDAQ:MU), as well as European chipmakers, also fell on the news.

WDC Stock Was Just Emerging From a Lawsuit With Toshiba

WDC stock had just recovered from a controversy over the state of its joint venture with Toshiba Corp (USA) (OTCMKTS:TOSYY). Western Digital and Toshiba became partners when WDC purchased Sandisk Corporation last year. The partnership has been turbulent as WDC has protested Toshiba’s sale of its chip unit to Bain Capital, LP for $18 billion.

Western Digital contends the joint venture gives it the right to approve this transaction. The Bain consortium, made up of Bain, Toshiba, Apple Inc. (NASDAQ:AAPL), Seagate Technology PLC (NASDAQ:STX) and SK Hynix Inc, has pushed back.

The consortium contends WDC’s claims are misleading. It’s also implicitly threatened Western Digital’s rights to flash memory access.

Toshiba will face a liquidity crisis if a sale does not go through by next spring. Most analysts believe Toshiba will eventually agree to Western Digital’s conditions. When investors saw a path to victory, WDC stock recovered.

Hence, while the Toshiba lawsuit wasn’t a long-term detriment to the WDC stock price, the sudden increase in NAND memory supplies could be a different story. When a supply glut hits the chip market, chip stocks have fallen dramatically in the past. WDC stock fell from $115 to $35 per share in less than 18 months the last time a memory price collapse occurred.

Bottom Line on WDC Stock

While not all analysts agree the NAND memory shortage has ended, given the history, prospective buyers should approach WDC stock cautiously. The appreciation of WDC stock paused and even went down briefly during its lawsuit with Toshiba. Just when it was entering recovery mode, Morgan Stanley predicts the end of the NAND memory shortage.

While not all agree, Western Digital should be approached cautiously. NAND memory makes up a critical component of WDC’s profit margin. If NAND prices start to crash, WDC stock will crash along with it. Unfortunately for WDC bulls, the stock appears to be a better short bet at this juncture.

As of this writing, Will Healy is long MU stock.

Article printed from InvestorPlace Media, https://investorplace.com/2017/11/why-lower-memory-prices-will-hit-western-digital-hard/.

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