Finding Value in Data Storage

Using Guru Focus' Undervalued Predictable Screener, and excluding OTC stocks, I looked for a company that traded at a discount to cash flow and paid a dividend.  One of those stocks was Western Digital Corp.

Business description

Western Digital Corp. (WDC) is one of the top developers and manufacturers of data storage solutions to preserve digital content.  Their clientele includes individual consumers, businesses, governments, and other organizations.  Their primary product is hard disk drives, and have been growing their product line to include solid state drives.

What matters most: Cash money

Before we talk about the company's cash holdings and ratios, I think it's important to talk about its debt. WDC has $2.3 billion in long term debt, and of that, $125 million is currently due with the year.  The amount of debt on WDC's balance sheet isn't a major cause for concern because the company has over $4.8 billion in cash.  WDC's current ratio is 2.29 and their quick ratio is 1.86 meaning WDC has a stong cash position and is able to convert it current assets into cash to pay for its current liabilities.  WDC could even cover its debt more than 2 times with just cash alone!  I usually like to invest in companies with a P/FCF of 15 or below, and would consider adding a stock to my portfolio if it fits this criteria.  WDC has operating cash flow of $2.8 billion and free cash flow per share of $9.04, giving it a P/FCF of 9.3, which is really attractive.

Dividends - The privilege of ownership

I like to invest in companies that pay a dividend in order to reduce my risk, earn a return on my capital invested, and reinvest those dividend payments into a snowball of dividend checks. WDC began paying dividends in 2012, and has been steadily increasing their dividend.  They currently pay $.40 a quarter, with a current yield of 1.7% and an annualized yield (if they continue to pay their current dividend) of 1.85%.  Thier dividend payout ratio, when compared to earnings, is 19% and just 17.6% when compared to free cash flow.  WDC can comfortably increase its dividend, especially since it has a strong cash position and cash flow from operations. I like to do some calculations to see how long it would take one share of a company's dividend payments to equal another share, if prices remained the same and dividend payments were held for the sole purpose of buying one more share, with no compounding. It would take 54 years for one share to become two WDC shares with the current level of dividend payments. I also like to calculate how many shares an investor would need to buy now in order to generate the equivalent of one share in dividend payments a year, all else being equal. It's interesting to note that, if an investor wanted to generate the cash in dividend payments for one share this year, it is equal to the amount of time it would take for one share to double from its dividend yield. Buying 54 shares would result in an extra share at the end of the year, generated by passive dividend income.

Book Value - Real Company Value

WDC's P/B ratio is 2.3, meaning it is priced more than double its actual value. I personally like to invest in companies with a P/B ratio of 2 or less, and in some cases I'll invest in companies with a higher P/B if the income stream of dividends is worth paying more for it.  I'm not sure if  WDC is worth paying a little extra for its dividend income, even though it does have a strong balance sheet.

Income - How well a company is managed

I normally don't like to rely on the income statement as a measure of value. I do think it offers the best glimpse of how well a company is able to manage its expenses while generating revenue, but I'll rely more on the cash flow statement to find value. WDC's  P/E ratio is 12.8. Most people invest in companies that have a P/E ratio between 15 and 25, while companies with a P/E ratio of 20 are seen as fairly valued. Honestly I don't care too much about P/E ratios, but it can help me gauge whether or not I can pass up on a company that is priced too high, and look for other companies. WDC has a gross margin of 28.8%, an operating margin of 11.8% and a net margin of 10.6%.  This tells me that most of the expenses WDC incurs has to do with developing and manufacturing their products.

Valuation

Using Guru's DCF calculator and inputting FCF of $9.04 we get a valuation of $244.09 a share, and $268.89 a share after adding tangible book value. Since the company has so much property and equipment it's import to consider their tangible book value per share. The company is very cheap when looking at its P/FCF, and P/E ratios.  This could present a potential buying opportunity for an investor that is interested in buying a company with a solid balance sheet and cash generating abilities. An investor would have to seriously consider their investment philosophy and see whether investing in this business coincides with their investment objectives.

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