Sunday, 1 August 2010


This is a stock that the Raven has been keeping quite a close eye on the last couple of weeks (he's traded around a small punter sized position). The company makes hard drives, the Raven actually uses one of their external hard drives to back up all his data.

This stock is cheap, by whatever metric you'd look at it classically, if you're using historic data it looks cheap. EV/ebitda(ttm) its 1.84x, p/e(ttm) 4.5, p/s 0.6, p/b 1.32, forward p/e 5.7.

This looks like a three legged dog with fleas. a blind three legged dog. Its fallen 41% since its high towards the end of April. Its done 40% more volume than one would have expected in that period as well. The 200dsma is 44% higher, basically its ugly, and looks oversold, but thats not a reason for it turn tomorrow.

Index funds, mutual funds and relatively passive money, so who's been selling??
4.3% of the float is short, 1.8 as a SR. (as of the middle of the month - so not very informative), not particularly high.

Going through some of the fears;
1) SSD tech becomes cheap enough to shut out HDD
2) inventory build up and volatile ASP (normal hardware producer risk really)
3) the "cloud"
4) areal growth rates too high or too slow (too high drives down the margin, too slow and SSD becomes cheaper relatively)

There is a lot of uniformed speculation as to what the fear is in the stock, the Raven doesn't claim to be any wiser than the street on this one, so its best to go through the obvious angles and see if it makes a bit more sense. SSD technically just isn't cheap enough to be competition just yet, the Raven also knows enough about the street to realize that this isn't a risk that has suddenly been priced in since April!! Neither is the cloud, or projected areal growth rates. So clearly by process of ellimination, investors are worried about inventory build up, pricing, etc. A "normal" fear in this sort of stock.

Listening to $STX and $WDC's earnings calls, its pretty clear that they both saw the same thing, the rather ominous sounding "third player" in their space producing an excess of 5mm units. They both speculate whether this is because the TP doesn't have as much control as they do, ie. aren't able to dial down their production as quickly, OR whether this is a deliberate shot at trying to gain market share with a limited number of OEM (original equipment manufacturers) that the TP is particularly close with. To the Raven the latter makes sense. In which case one should go and give the margins and balance sheet a good kicking to check how cheap the stock really is?

Ok, so looking at the suspected TP's driving down prices, the Raven thinks 'they' are running on a gross margin of ~15%, but also with higher r&d costs, and probably lower net margins than either STX or WDC. It does mean however that pricing could be quite weak, with bloody noses all round (although quite STX and WDC management seem quite aware of the danger of chasing market share thankfully). The Raven does think that the most conservative level is a 15% drop in ASP (average selling price). In which case WDC becomes break even, and worth ~ $11 of the cash its got on the balance sheet.

Realistically its easy to see WDC's margins get compressed down to 15% in the short term to match our TP's lower margins. That would mean EPS ttm of $1.95 ish. Putting that on a "value" p/e of 10x and you've got $19.50+$11cash = $30.50. So its only 16% higher than Friday's close. Certainley not bargain basement valuation in this scenario, putting a margin of saftey of 25% on that and you're at $23. (if you're a real punter though you could argue that you should use a market multiple of 14x and a 25% discount then you're looking at $28.73)

The other general trading point the Raven would make is that there seems little point being a hero, or draw a line in the sand, its much easier to trade the right hand side of a U than the left hand side, or "don't catch a falling knife", or "monkey's don't pick bottoms", etc, etc. Basically IF the Raven thought this was a screaming buy from a valuation standpoint, he's nimble and small enough to wait until the stock starts to move up before starting to buy. He's had a quick run of some quantitative screens and he'd only buy this stock when it broke throught its five day moving average on the shortest time frame.

So to sum up;
Looking in the rear view mirror, WDC is cheap. However the stock is telling traders and investors that there are worries about the future, by process of elimination it is 'clear' that market level inventory build up and weak margins going forward are a big risk given other market participants increasing supply and being less responsive to demand. The Raven believes that as a worst case scenario the stock trades at $11, at a realistic downside the stock is worth $30.50, so the Raven would look to buy a meaningful portfolio sized position if the stock went below $23 with the condition that the stock broke above its 5dma after that.

No comments:

Post a Comment