Western Digital

Western Digital delivered another exceptional quarter, with fiscal fourth-quarter revenue rising 44% year over year to $3.75 billion and non-GAAP gross margin expanding to 54.4%, both at or above the high end of guidance.

Why it matters: While results were solid, compared with our expectations, revenue was a slight miss, driven by less exabyte growth than expected even as pricing hikes exceeded our expectations. This, combined with slightly less bullish commentary compared with Seagate, is likely driving some of the selloff after hours. While Seagate and Western Digital will inevitably be compared, we thought results were still good in an absolute sense. Guidance for the next quarter is solidly above expectations, and demand and visibility commentary were both quite positive. For visibility, Western Digital is now negotiating long-term agreements with customers extending through calendar 2031. Like Seagate, Western Digital is seeing demand broaden beyond hyperscalers to neoclouds, frontier labs, sovereign deployments, enterprise, and physical-AI applications.

The bottom line: We are raising our fair value estimate to $420 from $415 as we revise our near-term EPS estimates (2027 and 2028) up by 25% and 29%, respectively. We simultaneously have lowered our implied multiple on 2030 earnings to account for potential peak-cycle risks. Shares are down 10% after hours to roughly $465, further closing the gap with our fair value estimate. Shares are down materially from a peak of nearly $750. We currently project a five-year EPS CAGR of 51% for Western Digital, very close to our Seagate projections. The HDD players remain tough to value. If the current cycle extends beyond 2030 and the market gives credit for this, there is upside to our fair value and today's prices, and vice versa if the cycle falls. Our current fair value estimate contemplates a 7% near-line pricing CAGR through 2031.

Our fair value estimate is $420 per share. Our valuation implies an adjusted fiscal 2027 price/earnings ratio of 20 times, although we expect strong earnings growth will help Western Digital grow into a midteens multiple by fiscal 2027. Our model implies a forward P/E of 9 times by 2029 (for 2030 projections), roughly 1 turn lower than our valuation for Seagate. The debate around the maintainability of the current cycle remains key, and depending on how long or short the cycle is, a higher long-term multiple, for a company growing EPS at a CAGR of roughly 50%, could certainly be warranted. To us, this is the key upside and downside in the name.

Western’s stock has historically swung wildly, along with its revenue and margins, depending on the HDD cycle. While HDDs have historically been quite cyclical, a key part of our thesis is that the industry will be more stable over time due to demand primarily coming from data centers. We also assume the HDD industry has some indefinite staying power in the data center ecosystem. If we reach a point where HDDs are replaced even in data centers, there would be downside to our fair value estimate.

We expect Western Digital to increase its revenue at a compound annual growth rate of 31% from fiscal 2026 through 2031. HDD growth is largely driven by data center nearline storage demand, which we expect to be robust, driven by AI-related demand.

We expect Western’s gross margins will be structurally higher than in the past, driven by steadier data center demand and more disciplined pricing and supply management from the HDD industry. Surging AI and cloud storage demand is leading to an upcycle for the HDD industry, with higher exabyte shipments and less pricing degradation driving gross margins higher. While we previously believed that gross margins of 40% would represent the peak, we now model gross margins of 60% in most years of our forecast. There arguably could be upside to this, given incremental gross margins of closer to 80% recently. This is driven by pricing gains from HAMR shipments (pricing per terabyte does not deteriorate to the same degree as it has in the past, allowing Western to capture more of the economics), which is enabled by more predictable demand from data centers and more discipline in supply from the HDD makers. The company is already hitting gross margins of well over 50%.

We think operating margins will continue to improve as Western gains operating leverage by shipping an increasing amount of exabytes, generating more revenue while maintaining roughly the same unit shipment amounts. We see inherent operating leverage in this business, and have Western hitting midcycle non-GAAP operating margins of 50% plus over the long term. We don't see why operating expenses will need to grow at more than a mid- to high-single-digit percentage annually, which should lead to good margin expansion.

We do not think Western Digital possesses an economic moat. Western Digital is a leader in the hard disk drive market. HDDs etch data onto spinning magnetic disks and have been around in one form or another since the 1950s. While the HDD market has high barriers to entry, given the massive capital investment required along with the technical expertise needed to design and manufacture industry-leading HDDs, we find the industry is not amenable to moats because HDDs are commodities with no pricing power. This leads to occasionally brutal business cycles and erodes economic profits. Even though the industry is a functional oligopoly. We project that returns on invested capital will roughly match Western Digital's cost of capital.

The HDD market is an oligopoly—but practically a duopoly—with Western Digital and Seagate each controlling roughly 40% of the market and Toshiba at less than 20% share. HDDs serve two distinct market segments: consumer drives for computers and gaming, and mass-capacity enterprise drives for data centers. The former segment is undergoing a rapid decline, as solid-state drives built with NAND flash take over the consumer market. Compared with HDDs, SSDs are smaller, more durable, more energy-efficient, and much faster. They are also more expensive, which has historically been the bottleneck to full-scale adoption. However, the price gap between HDD and SSD has narrowed as flash technology advances. As SSDs now offer a better value proposition for consumer devices than HDDs, the share of HDDs in these devices has fallen.

For mass-capacity enterprise drives (also known as nearline drives), the cost discrepancy between HDD magnetic recording technology and flash is material. Western Digital and Seagate are continually improving areal storage density and implementing new technologies such as heat-assisted magnetic recording to further reduce the cost per HDD gigabyte at large-capacity points. As a result, the enterprise SSD cost per terabyte is still roughly 6-7 times more than a comparable HDD. On a total cost of ownership basis, the difference is still likely 3-4 times. With projected improvements in HDD capacity through 2030, getting to drives with 50 TBs or more of storage, we expect this gap will remain, keeping HDDs the more attractive option for data center nearline storage for the foreseeable future. Mass-capacity HDDs store the vast majority of data in a data center, and only “hot data”—newer data expected to be accessed frequently—is stored on enterprise SSDs for faster access.

While we do not have any immediate concerns about HDDs' technological obsolescence in the data center, product road maps generally extend only to 2030, and there is always a tail risk of better-than-expected SSD developments after 2030 or unforeseen hiccups in HDDs' own future development road map. As such, our first key concern is the tail risk of obsolescence for HDDs over the next decade, even if we view this risk as unlikely for the near to medium term.

End customers don't care which brand of HDD they use, and HDDs are interoperable, meaning customers can use HDDs from any manufacturer. As such, the market is driven by supply and demand. While companies like Western Digital can earn economic profits in times of tight supply, as supply inevitably expands and prices fall, the firm becomes vulnerable to economic losses. Given the cyclical nature of the industry, the potential for economic losses during a cycle, and the lack of any pricing power at the product level, we believe a no-moat rating is appropriate.

This is somewhat counterintuitive, as we believe both Western Digital and Seagate possess significant intangible assets in the design and manufacture of mass-capacity HDDs. These are complex technologies that require significant investment and technical expertise, making barriers to entry high in the HDD industry. But the remaining players in the industry are unable to translate these intangible assets into any pricing power, so they struggle to generate long-term economic profits.

Competition in nearline HDDs occurs primarily on the basis of capacity expansion and lowering the total cost of ownership for customers. Western and Seagate are constantly developing higher-capacity drives for enterprises; both have road maps for producing 36 TB drives and beyond, with long-term goals of reaching 100 TBs or more. This continues a constant pattern for the industry where both key players generally make similar technological progress and then compete on price to sell their HDDs. Even as the industry sells more storage over time (the number of terabytes shipped increases every year), because technological progress makes these bytes cheaper and more efficient, the cost per terabyte consistently goes down each year. This is a classic sign of a commodity industry.

While we still expect prices per terabyte to decline over time, they could start declining at a slower rate than in the past as the ongoing artificial intelligence boom could be driving a structural shift in the industry, where demand from data centers is more stable and predictable than previous end markets the HDD industry focused on, and where the Seagate and Western Digital oligopoly becomes more disciplined on supply and pricing. While the industry has technically been consolidated with three players since roughly 2012, it may not be until now, with the shift toward data center demand, when the industry finally realizes the benefits of its consolidation. This will be a key development to keep an eye on. If there is a path to a narrow moat in this industry, this seems the most likely.

There have been instances where one side of the duopoly beats the other to a capacity node. For example, Seagate was the first to ship 16 TB drives and gained enterprise market share from Western Digital in 2020 (fiscal 2021) as a result. Nonetheless, Western Digital has mostly caught up, and market share has stabilized since. We generally believe the two firms will maintain technological parity over the long term and expect any initial product advantages will likely even out and stabilize over time as the other side catches up

Demand for data center buildouts is only increasing, driven by long-term structural trends such as AI and the Internet of Things. This could prolong the current upcycle and make it more durable than previous cycles.

Advancements in higher-capacity HDDs and new technologies like energy-assisted recording should modestly expand Western’s midcycle gross margin.

The HDD industry will be more disciplined on supply and pricing than in the past, which will reduce the cyclicality of the industry and increase profitability, warranting a higher valuation for Western.

The HDD market is commodity-like and cyclical, leaving Western vulnerable to market pricing declines that can shrink the top line and sink margins. In HDD downturns, these stocks can crater.

The HDD industry has been through upcycles before, but in the end, it always goes through another cycle.

The risk of HDD obsolescence, driven by displacement by SSDs, will always hang over Western. As more end markets phase out HDDs, the company is set to almost exclusively rely on the nearline storage market.