Western Digital (NYSE:WDC) put up strong results. WDC is more exposed to NAND while Micron (NASDAQ:MU) is one-third exposed to NAND. WDC cited strong industry dynamics helping their numbers improve. Similar trends should benefit Micron.
We went to a Buy Rating from Neutral on WDC on Dec. 12 (paywall).
Above you can see where we got more bullish. Here’s what we said at the time:
“With NAND pricing moving up I think this stock has bottomed. I think 5G and Apple moving along with pricing moving up and the stock near its lows is a great risk reward.
Really pricing is so important for memory exposed stocks. NAND pricing is now up after being down for a while. Let’s keep it simple, that’s good.
You saw me enter to WDC in our model portfolio. I want to go to a Buy Rating. It’s not as strong as a Strong Buy because I don’t have everything line up but I think this is something that can go.”
This story has been playing out. 5G and Apple are coming on along with other drivers I’ll talk about below. You saw me above get excited about pricing which you’ll see below was a core driver to their earnings taking the stock higher.
I do think short term it’s a little more fully valued but I think that medium term there’s still upside. I’ll explain.
Strong Memory Pricing
Western Digital had strong comments on pricing. Since memory companies are cyclical, pricing matters very much. In fact pricing is the single most important datapoint for me when doing work on WDC and Micron.
Here’s what Western Digital said on pricing:
“As we enter the March quarter, flash pricing continues to improve.”
“Relative to mix, I would say both product and market segment exposure and then of course the broader ASP pricing environment are going to be the drivers of the margin enhancement through the calendar year 2020.”
You hear them saying it here that the “pricing environment” is going to be a “margin enhancement” this year.
WDC is expecting a big margin turnaround now thanks to pricing.
Here’s their guide.
They guided to 29% gross margins. Look how that compares to their trend. It’s a big jump.
Source: Elazar Advisors models with data from Western Digital
Above you see the year-over-year trend go from negative 18% a few quarters ago to now up 4.1% in their guided March quarter.
You see how we model gross margins thereafter based on the improving two-year trend. They also said on their earnings call that gross margins could reach 35%-40% later this year.
Based on their guide gross margins plan to go from -5.4% year-over-year to +4.1% in one quarter’s time. That’s a 9.5% swing in one quarter which is huge.
The main driver is a combination of demand picking up and weak supply.
Here’s what they said:
“The other thing is that, as part of all that is, is that there is an increasing awareness on behalf of our customer base that inventory supply and demand is tightening up.
In other words, demand is going to exceed supply this year.”
Sweet words from a cyclical.
Demand is picking up. Some of that may be because customers see tight supply so they have to increase orders to make sure they get what they need.
That’s how cyclicals work. Under-ordering leads producers to cut production. Then there’s tight supply. Then you have over-ordering, sending prices up. Then producers chase prices with more production. Supply catches up then prices turn back down.
We’re back in the up-cycle where pricing is starting to move up which is the key beneficiary to the P&L.
Micron Benefits From Western Digital’s Trends
I view all this as support for the Micron thesis that they too are seeing similar trends.
Above you see from Micron’s earnings presentation that they are 28% NAND and 2/3 DRAM. I will say that memory trends tend to move together because they have many of the same end customers –datacenter, mobile, gaming, etc.
So tech needs memory, both NAND and DRAM, so general tech trends drive them both.
You heard WDC talk about pricing trends above. Here’s the DRAM chart seeing similar strength.
Above you see DRAM prices taking off. That’s benefiting Micron gross margins and earnings. I believe you have to stay on top of the datapoints to make sure your thesis is coming to fruition. WDC’s pricing comments match DRAM pricing trends and is another confirmation things are continuing in the right direction.
Again, these pricing trends are as critical as you get for both Micron and WDC.
China Health Issues
The health issues in China are a very tough story and we wish a speedy end to the spread of this problem.
China is very important to both Micron and WDC. Demand reduction is a risk to overall tech. But I believe they’ll find a cure soon or the epidemic will slow down.
For this reason though I think there’s a shot we get buying opportunities in both of these stocks.
I also think the combination of China health issues with the a potential Fed taper of their big repo buying support can give us decent buying opportunities. The Fed pulling back on quantitative easing type actions can soften up the market.
Upside and Conclusion
Currently I have WDC at about fair value. (Full model: Paywall). For Micron I have much more upside with an $85 12 month target (Full model: Paywall).
So I’m more bullish on Micron than WDC but think both benefit from the trends and both are worth looking for buying opportunities.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: All investments have many risks and can lose principal in the short and long term. The information provided is for information purposes only and can be wrong. By reading this you agree, understand and accept that you take upon yourself all responsibility for all of your investment decisions and to do your own work and hold Elazar Advisors, LLC, and their related parties harmless. All model portfolio trades are hypothetical to show direction, conviction and timing. Performance excludes all relevant transaction costs. Elazar and its employees do not take individual stock positions to avoid front running and other potential customer related issues.