Practice makes perfect. And boy, am I far from perfect.
In past efforts to research companies I have started with the soft stuff – descriptions of the business and industry. For this exercise I’ve armed myself only with the numbers – four years of financial statements. These are some notes/calculations I jotted down while reading. Western Digital is the company but who knows what they do ;).
Cash is a hefty portion of the balance sheet, roughly 33% of total assets as of 2015. The majority of that cash can be considered “excess” whether you use the 2% of sales rule of thumb or look at average working capital needs. My take is that this makes the balance sheet less risky, allows the company to use that cash (reinvest, acquire, dividend, repurchase, etc.), and ultimately makes any valuation ratios appear cheaper ex-cash.
On the liability side, things look pretty in-check too. The debt ratio has improved over the last four years and long-term debt is less than half of total liabilities.
Inventory appears well managed. I think the cash conversion cycle is probably more illustrative compared against industry averages but 20 days doesn’t seem too high. Additionally, I don’t notice any alarming trends comparing accounts receivable balances to sales.
After normalizing operating margins I would expect about 12% for this business. While margins have held up pretty well over recent years revenue has unfortunately declined at a -2.5% CAGR since 2013. Since I’m only in the numbers here, it’s hard for me to understand the why.
Interest expense is well covered by operating income. An income statement view affirms my thoughts from a balance sheet perspective.
I took a quick peek at Other Comprehensive Income just to make sure there weren’t any unusual charges I was overlooking. The majority falls under unrealized gain/loss on FX contracts and isn’t surprising.
WDC still throws off a lot of free cash flow though the trend is less than positive over the last few years. Maintenance capital expenditures were estimated by averaging the past couple years of depreciation and amortization expense.
I also took a quick look at the financing section with an eye out for possible dilution and capital uses and sources. The company pays a decent dividend to shareholders and has been purchasing back some stock. Shares have only been issued in conjunction with employee stock plans and represent less than total repurchases.
To get a sense for the quality of this company I broke out ROIC. An average of 21% is quite healthy.
I took two approaches to valuation. My normalized operating margin of 12% suggests a Price-to-Sales ratio of 1x (see #8 on my valuation post for more information). A quick check on Bloomberg shows estimated revenue of about $12.5 billion in 2016/2017 and shares outstanding of nearly 233 million. This implies a value of $53.60 per share, roughly 20% higher than current prices.
Alternatively, I considered what normalized FCF might look like. An average of the last four years suggests more than $1.5 billion. 2015 FCF suggests slightly less than $1 billion. Finally, taking the estimated sales from Bloomberg along with a 12% operating margin, 8% average tax rate, and working capital/capex/depreciation needs in line with the cash flow table above, we get somewhere around $1.3 billion. If I capitalize this final in between number at 10% (estimated cost of capital), subtract debt of $2.5 billion and give no credit for “excess cash” due to the favorable tax jurisdiction I get a value of $45 per share or pretty much current prices.