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Better Buy: Western Digital vs. Texas Instruments

Leo Sun, The Motley Fool

Western Digital (NASDAQ: WDC) and Texas Instruments (NASDAQ: TXN) both struggled last year. Soft demand for hard drives and tumbling NAND flash prices throttled WD's growth, while TI struggled with soft sales of its embedded chips across multiple industries.

I compared these two stocks in early January, and concluded that TI's better-diversified business and lack of exposure to the NAND market made it a safer play than WD. Since that article was published, TI's stock has rallied over 20%, but WD's stock has surged more than 30%.

Today, I'll discuss why WD outperformed TI this year, and whether or not that trend will continue throughout the rest of 2019.

A bull climbing a rising stock chart.

Image source: Getty Images.

The differences between WD and TI

Western Digital is one of the two largest makers of traditional platter-based HDDs (hard disk drives) in the world. HDDs face tough competition from flash-based SSDs (solid state drives), which are smaller, faster, more power efficient, but more prone to damage.

To avoid being left behind the tech curve, WD acquired SanDisk, one of the world's top makers of flash memory and SSDs, in 2015. That acquisition significantly boosted WD's revenues, but it also increased its debt and added exposure to cyclical NAND prices. Last quarter, 56% of WD's revenue came from HDDs, and the rest came from SSDs and other flash memory products.

Texas Instruments sells a wide range of analog, embedded, and other types of chips to a wide range of industries. Last quarter, 70% of its revenue came from analog chips, 22% came from embedded chips, and the remaining 8% came from other types of chips.

Most of TI's growth comes from the automotive and industrial sectors, since connected cars and automated machines require a growing number of chips. However, sales of chips for personal electronics were soft in recent quarters, due to the saturation of PC and smartphone markets.

Which company is growing faster?

WD's HDD business faces slower demand from PC makers, due to Intel's (NASDAQ: INTC) ongoing chip shortage throttling production of PCs, slower demand from enterprise and cloud customers, and competition from SSDs. Meanwhile, its flash-based products are struggling with ongoing declines in NAND prices worldwide.

However, Intel expects to resolve its chip shortage issues by the end of the year, and NAND prices should gradually bottom out. This indicates that WD's declines could be approaching a cyclical bottom. Here's how WD fared over the past year:

YOY growth

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Revenue

8%

6%

(3%)

(21%)

(27%)

Non-GAAP EPS

52%

23%

(15%)

(63%)

(95%)

Source: WD quarterly reports. YOY = Year-over-year. 

The midpoint of WD's fourth-quarter guidance calls for a 27% annual decline in revenue and a 94% drop in its non-GAAP EPS. On a sequential basis, that would represent flat revenue growth and 17% earnings growth -- which indicates that the worst might be over. WD also expects its gross margin to remain nearly unchanged from the third quarter.

A platter-based hard disk.

Image source: Getty Images.

Texas Instruments' business is more diversified than Western Digital's, but it's still vulnerable to broader economic downturns. Here's how TI fared over the past year:

YOY growth

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Revenue

11%

9%

4%

(1%)

(5%)

EPS

39%

33%

25%

274%*

(7%)

Source: TI quarterly reports. YOY = Year-over-year. *Caused by a tax reform charge in the prior year quarter.

TI's growth is decelerating, but it doesn't seem to be approaching a cyclical bottom like Western Digital. The midpoint of TI's forecast for the second quarter calls for a 10% annual drop in revenue and a 13% decline in earnings. On a sequential basis, that would represent roughly flat revenue growth and a 5% earnings decline.

During the conference call, TI CFO Rafael Lizardi warned that cyclical downturns "typically" go through four to five quarters of year-over-year declines. TI's sales declined year over year for only two quarters, so Lizardi's comments indicate that the rest of 2019 could be rough -- mainly due to tepid demand for its automotive and industrial chips.

On the bright side, TI's gross margins remain comfortably above 60%, thanks to a shift from 200mm to 300mm wafers that cut its production costs by about 40%. It also remains dedicated to returning all its free cash flow to shareholders via buybacks and dividends. WD, which finished last quarter with a negative free cash flow, is currently dipping into its cash reserves to make its dividend payments.

The winner: Western Digital

Western Digital's growth metrics initially look dismal, but the business is approaching the end of a cyclical downturn, its stock trades at just 10 times forward earnings, and it pays a hefty forward dividend yield of 4%.

Texas Instruments, however, is still in the middle of a cyclical downturn. Its stock is pricier at 20 times forward earnings, and it pays a lower forward dividend yield of 3%. TI remains a solid long-term stock to own, but WD currently has more immediate upside potential.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of Texas Instruments. The Motley Fool is short shares of Western Digital. The Motley Fool has a disclosure policy.