Investing.com -- Western Digital Corp (NASDAQ: WDC ). has had its credit rating upgraded from 'BB' to 'BB+' by S&P Global Ratings following the company's decision to spin off Sandisk. The outlook for the tech company remains stable. Western Digital clarified its financial policies and capital structure as a stand-alone entity after the Sandisk spinoff, which is expected to close later this month.

The company will receive approximately $600 million from Sandisk as a net transfer at separation, along with a 19.9% stake in the divested business. This stake is expected to be monetized to reduce debt levels within the next year. Western Digital's management has also stated it will aim to maintain net leverage between 1.5x and 1.0x.

The credit rating boost reflects S&P's forecast for post-spin deleveraging, conservative financial policies, and ongoing near-term growth in hard disk drive (HDD) sales. S&P has also affirmed its ‘BBB-’ issue-level rating on the firm’s senior secured debt and raised its issue-level rating on the firm’s unsecured debt to ‘BB’.

Western Digital's cash position, as of December 31, was $2.3 billion. This, combined with the $600 million transfer from Sandisk, the firm's $7.4 billion of gross debt, and about $560 million of other adjustments, will provide the standalone firm with an adjusted net debt balance of about $5 billion. Revenue growth of over 40% is expected in fiscal 2025, and estimated pro forma EBITDA margins of over 25% will enable the company to reduce its net leverage to under 2.0x in fiscal 2025, a significant improvement from 6.4x in the previous year.

The company's management clarified its stand-alone financial policy at its investor day last week, stating a target net leverage level of 1.5x-1.0x. Shareholder returns beyond a modest dividend will be postponed until leverage reaches the target range.

Western Digital and its primary competitor, Seagate, have benefited from a rapid rebound in storage demand over the past year. Western Digital reported revenue growth in its HDD business of over 80% in the first half of the current fiscal year. This is a significant recovery from a severe recent downturn, which saw the firm’s HDD revenues decline by 31% in fiscal 2024.

The recent rebound in sales has been accompanied by an impressive improvement in profitability for Western Digital’s HDD business, with segment gross margins reaching over 38% the past two quarters, up from a nadir of about 21% in the December 2023 quarter.

Despite these improvements, the HDD industry will continue to be reliant on capital spending budgets of a handful of large cloud service providers. Western Digital does not have significant recurring revenues, and as a manufacturing business, fluctuations in volumes and utilization could lead to a deterioration in cash generation and credit metrics.

Western Digital's post-spin liquidity position and target leverage levels should give the firm considerable flexibility to weather future industry cycles. The company's free cash flow to debt is expected to exceed 30% in fiscal year 2026, which further supports its ability to deleverage.

S&P Global Ratings could downgrade Western Digital if a downturn in the HDD market leads to declining revenue, EBITDA, and cash flow. An upgrade could be considered if the company continues to reduce its leverage and maintains a leading technology position.

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