Morgan Stanley: Western Digital's NAND Forecast May Be Overly Bullish

Memory chip partners Western Digital Corp WDC and Toshiba Corp (USA) TOSYY announced a settlement agreement Tuesday to resolve their ongoing disputes in litigation and arbitration. The agreement provides for the companies to participate jointly in future rounds of investment in Fab 6, a fabrication facility under construction in Japan, including a second tranche announced by Toshiba in October.

The companies also extended the terms of their Flash Alliance joint venture through 2029 and Flash Forward through 2027.

The Analyst

Morgan Stanley analyst Joseph Moore maintained an Equal-weight rating on Western Digital and increased the price target from $90 to $92.

The Thesis

The resolution with Toshiba provided certainty on long-term NAND supply, Moore said in a Wednesday note. (See Moore's track record here.) 

Western Digital's bullish view on NAND strength in the second half is debatable and limits upside to the company's settlement with Toshiba, the analyst said. 

Western Digital expects the flash supply-demand environment to remain healthy throughout calendar 2018, an increase from its prior guidance for the first half of the year, Moore said. But Morgan Stanley said the NAND cycle is entering a downturn for the first time since the first quarter of 2016, with the cycle indicators making the firm's analyst more cautious.

Western Digital increased its calendar 2018 revenue growth guidance to the high end of its 4-8 percent long-term revenue target, and calendar year 2018 gross margin guidance above the 33-38 percent long-term target range, according to Morgan Stanley. 

"WD referenced greater visibility, longer dated conversations with customers and overall demand driving the [company's] view that favorable NAND dynamics continue through 2H18," Moore said. 

Although the short-term trends are in balance after a prolonged period of shortage, Moore said the scenario could get worse before getting better, given accelerating supply and elastically decelerating demand.

Flash industry bit growth is expected to come in at the low-end of the 35-45 percent range in calendar 2017 and within that range in 2018, Moore said. The transition to 3-D NAND remains on track, with over 65 percent of bit output on 3-D flash and more than 90 percent of flash bit output on 64 layer.

With the expectation that NAND pricing will soften, particularly in the second half, Morgan Stanley said it expects revenue growth to be at the low end of the company's long-term target range.

Due to competition from flash pressuring HDD gross margins, Morgan Stanley expects gross margin to fall at the high end of the long-term guidance range. 

The Price Action

Western Digital shares are up about 24 percent year-to-date. The shares were up 2.27 percent at $83.63 at the close Wednesday. 

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