Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Just a couple of weeks from today, tech behemoth Western Digital (NASDAQ: WDC) will report its fiscal Q3 2019 results, after close of trading on April 29. On Wall Street, analysts are feeling optimistic -- and impatient to get in on Western Digital stock before good news sends it higher.
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Yesterday, we learned that Longbow Research had upgraded Western Digital from neutral to buy and assigned the stock a $65 price target. Today, Deutsche Bank followed suit and upgraded Western Digital stock.
Here's what you need to know.
Western Digital wins fans
All month long, in fact, Wall Street has been singing Western Digital's praises in the run-up to Q3 earnings. Last week, investment bankers Loop Capital and RBC Capital raised their price targets on the flash memory and hard drive maker to $53 and $60, respectively, citing stronger spot prices on solid-state NAND memory and "improving PC demand, data center ramps, and smartphone" sales in China, according to reports from TheFly.com.
Loop in particular predicted we'll see stronger performance by Western Digital in the second half of this year as unit shipments of hard drives improve by 20% to 25%.
Second-half improvements are in fact key to this week's upgrades as well -- and analysts see these improvements extending beyond hard drives and into NAND.
Yesterday, Longbow noted that NAND fundamentals are approaching a bottom, and a cyclical recovery in NAND appears to be in sight. As the analyst explained, NAND prices (and profits) have been under pressure due to waning demand. Production, however, is being "rationalized" as industry players cut production to levels more consistent with demand, which holds out the prospect of better profits as time goes on.
Deutsche Bank's upgrade
Deutsche Bank agrees, citing supply cuts across the NAND industry combined with renewed demand for hard disk drives (HDD) as potentially providing a double whammy benefit for Western Digital's profits.
"We are starting to observe favorable data points in both HDD and NAND that will support a solid 2H CY19 recovery for WDC's earnings," quotes StreetInsider.com (subscription required). NAND prices may be weak currently, leading Deutsche to lower its expectations for Q3 earnings, but "supply cuts across the NAND industry, along with a re-acceleration of nearline HDD demand, will likely lead to a stronger recovery off a lower base in 1H CY19."
Accordingly, Deutsche is going out on a limb to predict better earnings in H2 2019 and into 2020 -- and upping its price target on Western Digital to $60 a share.
What it means to investors
Admittedly, Deutsche's $60-a-share prediction for Western Digital today only amounts to about a 10% gain over the next 12 months. (On the other hand, Western Digital also pays its shareholders a hefty 3.9% dividend yield, so your actual total return could be closer to 14%.)
Is that really all investors can expect, though?
Actually, I think the situation might be a bit better than that. Consider:
Although Western Digital has reported only about $841 million in GAAP profits over the past 12 months, its free cash flow number is quite a bit higher -- $2.1 billion. Weighed against the company's $15.1 billion market cap, that works out to a price-to-free-cash-flow ratio of only 7.2, which is hardly a challenging valuation on a stock that most analysts agree can grow earnings at 10% annually over the next five years, and that pays a near-4% dividend yield.
Granted, Western Digital does carry a heaping helping of debt -- $6.6 billion net of cash on hand, lifting its enterprise value to $21.7 billion. But even factoring debt into the picture, I see the stock as trading for an enterprise value only 10.3 times trailing free cash flow. And if you agree with these analysts that Western Digital is due for a rebound in sales and profit margins, it seems likely that free cash flow number will only get bigger in the months and quarters to come.
Long story short: I'm in agreement with the analysts on this one. Now seems a fine time to buy Western Digital stock.
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