WDC's AI-Driven Surge Masks Overvaluation and Cyclical Risks

What happened

Western Digital's stock has surged 87% over the past three months, driven by AI-driven storage demand boosting margins and cash returns, as highlighted in recent news. This spike is part of a larger 289% rally over 12 months, pushing valuations to elevated levels of 24.5x P/E and 34x EV/EBITDA. The company, now a focused HDD vendor after separating its Flash business, relies heavily on cloud customers for 88% of revenue, exposing it to high concentration and cyclical demand. Despite the recent earnings rebound from operating leverage off a trough, structural challenges persist, including HDD share loss to SSDs, leverage, and volatile pricing. With the stock trading 271% above a DCF-based intrinsic value of $48.88, the current price embeds overly optimistic assumptions about sustained AI growth, ignoring historical volatility and business risks.

Implication

The stock's surge reflects market excitement over AI storage demand, but this overlooks Western Digital's exposure to a structurally challenged HDD market with high customer concentration. Elevated multiples are unsustainable for a capital-intensive, cyclical business, suggesting a sharp correction if demand or pricing normalizes. The DCF estimate indicates significant overvaluation, implying current prices discount perfection in AI tailwinds without accounting for normal downturns. High leverage and ongoing share buybacks reduce financial flexibility, increasing vulnerability during industry softness. Therefore, investors should wait for a substantial price correction or clear evidence of durable mid-cycle profitability before considering a position, aligning with a cautious stance.

Thesis delta

The recent 87% price surge does not alter the fundamental overvaluation thesis; instead, it exacerbates the disconnect between market price and intrinsic value. This reinforces the view that investors are extrapolating near-term AI tailwinds into perpetuity, underestimating cyclical volatility and structural HDD decline risks.