WDC - Western Digital Will Benefit From Samsung's Production Cuts But Macro Headwinds Could Dampen Memory Recovery

2023-04-11 10:33:29 ET

Summary

• Western Digital and Micron have had substantial inventories to work through, causing memory prices to drop significantly.
• Samsung’s decision to reduce memory chip production should alleviate the inventory overhang in late 2023 with a recovery in memory revenues in early 2024 for Western Digital and Micron.
• Smartphone and PC data point to the start of a recovery in 2023 that won’t move to positive YoY growth until 2024.

Samsung Electronics (SSNLF) announced it was substantially reducing its memory chip production after it reported its smallest profit since the 2009 financial crisis. According to the company's financial release, inventory had expanded to 52.2 trillion won at the end of 2022, as the company maintained production during a sharp decline in memory demand, while competitors Western Digital (WDC) and Micron (MU) announced sharp capex cuts.

The news should come as no surprise to my readers, and I reported in my March 29, 2023, Seeking Alpha article entitled " Micron: Q2 2023 Earnings Results As It Digs Itself Out Of Quagmire " more than a week before Samsung's Preliminary Earnings Guidance report for Q1 2023 on April 7 that:

"While Samsung initially indicated in its Q4 2022 it wouldn't cut production, my spot checks indicated that production was being cut by as much as 10%. At last, on March 23, 2023, Samsung Electronics announced it was cutting production more noticeably in the first quarter due to a severe supply glut and mounting inventory levels. In fact, it may have been as high as a 30% cut."

Previously, Samsung in its Q4 2022 earnings call noted its strategy that instead of cutting investment in response to slowing demand and falling prices, Samsung would curb short-term production organically through line maintenance, equipment

That said, the repercussions of the announcement that came out just while the U.S. stock market was closed for Easter on April 7 resulted in strong positive market reaction for WDC and MU. At the end of the first day of trading on April 10, 2023, WDC shares rose 8.22% and MU rose 8.04%. By way of comparison, the S&P was up just 0.10% and the Nasdaq was down 0.01% on the day.

The Memory Crisis

As a background to the memory crisis, in my Dec. 15, 2022, Seeking Alpha article entitled " Micron: Excessive Capex Spend Responsible For Plummeting Memory Market ," I demonstrated that while the dire economy has impacted demand, an underlying root cause is the excessive capex spend by memory companies in the prior year. Inventory oversupply at PC/smartphone customers is now intensifying in data centers and industrial sectors of memory chips with only automotive chips secure so far.

In this article, I present data illustrating the memory revenues and ASPs (average selling prices) continue to drop based on smartphone, PC, and server shipments and on cloud capex spend.

In my March 7, 2023 Seeking Alpha article entitled "Micron: A Bad 2022, A Dire 2023, A Positive 2024," I noted that many analysts are touting an uptick in consumer related items, particularly PCs and smartphones, in 2H 2023. I agree, but with an important proviso - 2022 was bad but 2023 will be worse as recovery won't happen until 2024.

Chart 1 shows quarterly unit shipments for smartphones (blue bar) and PCs (orange bar) from Q1 2022 to Q4 2024. Here we can see that shipments will reach a low in Q2 2023 and begin showing positive QoQ growth in Q3 2023. These data are according to our report entitled " Hot ICs: A Market Analysis of Artificial Intelligence ("AI"), 5G, Automotive, and Memory Chips ."

Chart 1

Western Digital and the Memory Crisis

WDC CFO Wissam Jabre reported at its Q1 2023 Earnings Call on October 27, 2022 the company was reducing its capex (capital investment) to slow down our bit supply in the market to try and get the market balance

"We are reducing our gross capital expenditures to $2.7 billion (from $3.2 billion). We are also aiming to reduce our cash capital expenditure by 20% versus our prior expectation. The main drivers of our lower capital expenditures are primarily the push out of BiCS6 transition in flash and reduced investments in hard drive manufacturing."

Why?

• WDC reported revenues of $3.74 billion in fiscal Q1, -26% YoY and -17% QoQ in its fiscal Q1 2023 call.
• The company's HDD (hard disk drive) revenues were $2.01 billion, -21% YoY and -5% QoQ.
• The company's flash memory revenues were $1.72 billion, -31% YoY and -28% QoQ.

Importantly,

• Inventory at the end of fiscal 1Q23 was $3.862 billion driven by NAND, which was up from $3.638 billion at the end of the previous fiscal 4Q22 and $3.544 billion YoY.
• Inventory was 128 days during fiscal 1Q23, up from 108 days the prior quarter.

But wait. It got worse.

• WDC reported revenues of $3.11 billion in fiscal Q2, -36% YoY and -17% QoQ in its fiscal Q2 2023 call.
• The company's HDD (hard disk drive) revenues were $1.45 billion, -34% YoY and -28% QoQ.
• The company's flash memory revenues were $1.66 billion, -37% YoY and -4% QoQ.

Importantly,

• Inventory at the end of fiscal 2Q23 was $3.770 billion driven by HDD, which was down from $3.862 billion at the end of the previous fiscal 1Q22.
• Inventory was 135 days during fiscal 2Q23, up from 128 days the prior quarter.

Table 1 shows Street estimates for fiscal 3Q 2023 ending March 2023. Flash is expected to continued its slide while estimates for HDD are expected to be positive. WDC said it expects third-quarter revenue to be between $2.6B and $2.8B. It expects to lose between $1.70 and $1.40 per share during the period, excluding one-time items, including underutilization charges in flash and HDD totaling $250M.

Table 1 also shows Street estimates for fiscal 3Q 2023 ending March 2023. Flash is expected to continued its slide while estimates for DRAM are expected to be positive.

Additional information is available in my Feb. 15, 2023, Seeking Alpha article entitled " Western Digital: Continuing To Underperform Seagate ."

Chart 2 illustrates total exabyte data shipped for both companies between F2Q19 and F2Q23. WDC outperformed Seagate (STX) until F2Q22, and the trendlines show cross at F2Q23 illustrating exabyte data has equalized.

Chart 2

Micron and the Memory Crisis

Micron is reducing its capex investments to reduce bit supply growth in 2023 and 2024. Fiscal 2023 capex is being lowered to a range between $7 billion to $7.5 billion from the earlier $8 billion target and the $12 billion level in fiscal year 2022. This represents approximately a 40% reduction year-on-year and we expect fiscal 2023 WFE to be down more than 50% year-on-year.

Micron's revenues were a bad if not worse than WDC's above.

• MU reported revenues of $3.69 billion in fiscal Q2, -52.6% YoY and -9.6% QoQ in its fiscal Q2 2023 call.
• The company's DRAM revenues were $2.72 billion, -52.4% YoY and -9.6% QoQ.
• The company's flash memory revenues were $0.89 billion, -54.8% YoY and -19.8% QoQ.

Importantly,

• Inventory at the end of fiscal 2Q23 was $8,129.
• Inventory was 235 days at the end of fiscal 2Q23, up from 214 days the prior quarter.

Memory revenues are shown in Chart 3 . Memory revenues dropped 43.3% between July 2022 to January 2023, as well as a continued 12.1% drop between December 2022 and January 2023. Within the memory market, DRAMs dropped 46.0% during the 6-month period and another 10.9% between December and January.

DRAM revenue was greater than NAND revenues, and based on trendlines (dotted lines), DRAM revenue growth was greater than NAND over the period July 2019 and January 2023.

Chart 3

Investor Takeaway

Driven by a mix of skyrocketing consumer demand followed by pandemic supply constraints, the traditionally cyclical memory industry moved along a new cycle that started in Q1 2021 and ended in Q2 2022. The downturn was amplified by a 40-year high inflation rate and recessionary fears that dampened demand primarily for consumer electronic products.

Memory prices are dropping due to a slowdown in shipments of consumer electronics products such as PCs and smartphones. As demand decreases memory chips aren't sold, inventory builds up, and spot prices decrease.

WDC's and MU's memory semiconductor inventories should peak in 1Q23 and decline after 2Q23 due to the supply cutbacks. As a result, industry conditions should improve from 3Q23. I also estimate a recovery in smartphones and demand of hyperscalers' data center investment in 2H23.

Samsung's production cuts are intended to speed up the recovery in memory-chip prices, as the company stops aggressively fighting to gain market share. As pointed out above, the cause of this inventory overhang has been excessive capex spend causing oversupply of memory chips. The reduction in demand for consumer electronics products following COVID lockdowns exasperated the oversupply.

These macro problems continue to dominate the investment scene due to poor financial and fiscal policies. Concerns about an imminent recession and escalating potential of community bank failures will dampen the pace of recovery.

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