A Look At The Intrinsic Value Of Western Digital Corporation (NASDAQ:WDC)

Key Insights

• Western Digital's estimated fair value is US$77.51 based on 2 Stage Free Cash Flow to Equity

• Western Digital's US$75.77 share price indicates it is trading at similar levels as its fair value estimate

• Analyst price target for WDC is US$87.67, which is 13% above our fair value estimate

Today we will run through one way of estimating the intrinsic value of Western Digital Corporation (NASDAQ:WDC) by taking the expected future cash flows and discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

View our latest analysis for Western Digital

The Model

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2025	2026	2027	2028	2029	2030	2031	2032	2033	2034
Levered FCF ($, Millions)	US$1.79b	US$2.00b	US$2.06b	US$1.91b	US$1.84b	US$1.80b	US$1.78b	US$1.79b	US$1.80b	US$1.82b
Growth Rate Estimate Source	Analyst x7	Analyst x4	Analyst x1	Analyst x1	Est @ -4.07%	Est @ -2.14%	Est @ -0.78%	Est @ 0.17%	Est @ 0.83%	Est @ 1.30%
Present Value ($, Millions) Discounted @ 8.6%	US$1.7k	US$1.7k	US$1.6k	US$1.4k	US$1.2k	US$1.1k	US$999	US$922	US$856	US$798

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$12b

The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.4%. We discount the terminal cash flows to today's value at a cost of equity of 8.6%.

Terminal Value (TV)= FCF₂₀₃₄ × (1 + g) ÷ (r – g) = US$1.8b× (1 + 2.4%) ÷ (8.6%– 2.4%) = US$30b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$30b÷ ( 1 + 8.6%)¹⁰= US$13b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$25b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$75.8, the company appears about fair value at a 2.2% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

dcf

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Western Digital as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 8.6%, which is based on a levered beta of 1.356. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Western Digital

Strength

• Debt is well covered by earnings.

Weakness

• Shareholders have been diluted in the past year.

Opportunity

• Expected to breakeven next year.

• Has sufficient cash runway for more than 3 years based on current free cash flows.

• Current share price is below our estimate of fair value.

Threat

• Debt is not well covered by operating cash flow.

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. DCF models are not the be-all and end-all of investment valuation. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For Western Digital, we've compiled three essential factors you should explore:

1. Risks: As an example, we've found 3 warning signs for Western Digital (1 is concerning!) that you need to consider before investing here.

2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for WDC's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.

3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com