Seagate Technology: Hard Drives Are Easy Sell for 2009

How big is your computer’s hard drive? I’ll bet dollars to doughnuts it’s a heck of a lot larger than it was 10 years ago.

Our data storage needs have changed substantially over the last decade. In the mid 1990s, your copy of Windows 95 took up a whopping 50 megabytes of storage space ­– today, an install of Windows Vista requires a minimum of 15 gigabytes.

And our appetite for hard drive space isn’t getting filled anytime soon. According to a recent article from computer website X-bit Labs, “Worldwide [hard drive] shipments are expected to grow in 2008, even in the face of economic uncertainty in the United States, and increase at a compound annual growth rate of more than 9% between 2007 and 2012.”

It’s no wonder why storage space is such a hot commodity… we live in the time of TiVo and the iPod. It’s surprising how many consumer electronics devices are equipped with hard drives for storage – from video game consoles to cars, everything seems to be popping up with a hard disk drive (HDD) installed these days.

Even hard drive veterans like computers saw their capacities increase throughout 2008. According to that same X-bit Labs article, “…worldwide disk storage systems capacity shipments will continue to more than double every two years, growing at a compound annual growth rate of nearly 53% from 2007 to 2012, while spending will pass the $34 billion mark in 2012.”

Part of this demand is fueled by software applications that require hefty amounts of storage to run. Apple’s (AAPL) consumer video editor, iMovie, uses uncompressed video that rings in at 25 megabits per seconds, meaning that an hour of video rings in at just under 12 gigabytes – no small chunk of space.

The same is true for the enterprise market. Hulu is an online service that lets users watch their favorite TV shows and movies online for free – many in HD. You’d better believe that the storage requirements for a service like that to run are staggering. Google’s (GOOG) in the same boat – as of this writing, the company’s free Gmail e-mail service offers 7,282 megabytes of free storage space per user.

With demand as strong as ever, now’s not a bad time to be a hard drive manufacturer.

The Best Hard Drive Company

There’s no shortage of competition in the hard drive arena. While companies like Western Digital (WDC), Xyratex (XRTX), and SanDisk (SNDK) have been successful in bringing profits to their investors in the last few years, none have the bargain appeal of Seagate Technology (STX).

Seagate is the world’s largest manufacturer of hard drives and data storage devices. The company sells its storage products to customers in every segment of the market (including consumer, OEM, and enterprise) under the Seagate and Maxtor brand names.

In the last year, the company took in more than $1.2 billion in income – a 38% increase over 2007 – but until now investors haven't been interested. As of this writing, the company’s market cap is a scant $2.7 billion. That’s an obscenely low valuation for a company that generated as much cash at STX did in 2008.

Looking at Seagate’s Value

From a fundamental standpoint, there’s no question that Seagate is a cheap company right now. STX has a P/E ratio of 3.07 – significantly shy of the industry average 7.88. Price to book stands at 0.54, suggesting that Seagate’s money-making assets are currently up for grabs for almost half of what they’re worth.

Imagine if you could pay a one-time fee of $100 today to get $32 of cash each and every year for the foreseeable future. With a price-to-free cash flow ratio of 3.11, that’s essentially what’s going on with Seagate. For comparison’s sake, the average S&P 500 stock costs 15 times as much for the same amount of cash generating ability.

Right now, the Seagate has a strong balance sheet with $1.2 billion in cash and very few intangibles on the books. And with a current debt load of $2 billion, Seagate’s ability to cover its expenses isn’t a concern despite the state of the economy. The company’s current financial health puts it in a good position to handle whatever hurdles may lay ahead in 2009.

Growth is key for a company like STX. Even though Seagate controls a large portion of the hard drive market (35% in 2007), the company has been able to deliver strong top line growth over the past few years; since 2005, sales have grown 68%.

That’s not to say that STX isn’t without its detractors. Heavy competition among hard drive manufacturers is a big concern for the company. With increasing operating costs serving as one of the main reasons Seagate’s margins contracted somewhat in its most recent quarter, cutting costs will have to be a top priority for the company to keep its current market stature.

Likewise, pushes toward new technologies could be another challenge for the company. With solid state drives (SSDs) like those found in the MacBook Air becoming more prevalent, Seagate needs to embrace a sales strategy that can promote SSDs alongside the traditional hard disk drives that are Seagate’s bread and butter.

So far, it looks like the company is up to the challenge. In a recent article on Cnet.com, Rich Vignes, senior manager of market development explained: “Our history is based on rotating magnetic media. But as solid-state comes online, we're embracing this new media type.”

The Bottom Line

Seagate Technology is a phenomenal value opportunity right now. The Rhino Stock Report model portfolio took its position at $4.53 in a Rhino Alert sent out to BETA subscribers on December 18, 2008. As of this writing, the stock is trading at $5.59, a price that still warrants a “BUY” rating from us.

STX could comfortably climb above the $10 range by 2010. I think that company EPS projections of $0.12 are reasonable given the current economic climate, and could increase substantially once increased consumer confidence translates into more sales.

Disclosure: STX is a long position in the Rhino Stock Report’s model portfolio.

Comments

[Tom Armistead:]

I am long STX via the Jan10 2.50 Calls. After listening to CEO Bill Watkins at the Barcaly's Capital Global Technology Conference on 12/10/08, my enthusiasm has diminished. I thought I heard a lot of stress in his voice, and very little confidence. They drew down their line of credit, citing a desire to enhance cash and liquidity, and recieved a downgrade (to junk) from Fitch.

Short to medium term I still like Hard Drives, for the fact storage needs seem to increase exponentially due to the proliferation of digital content.But Hitachi, Toshiba and Intel seem commited to making SSD comptetitve and the technology is potentially superior.

Comparing STX to WDC on ROI, ROA, ROE, inventory turnover and asset turnover is instructive: WDC is clearly superior on these metrics. Capex appears more disciplined and effective for WDC.

Comparing margins all the way to the bottom line for the past three quarters, WDC is developing much better than STX, which is faced with shrinking margins.

So, I like hard disks, there are extreme values there, but I would suggest WDC is superior to STX.

Jan 11 06:58 AM

[basehitz:]

I sold these shares last summer on profit warning at $16. So your article caught my attention. 80% off is a good thing. But doing the research suggests it's cheap for a reason. Their CEO recent comments are ugly and play right into credit rating downgrade in Dec to junk status with negative outlook raising liquidity concerns if free cash flow is sufficitnly impacted from possible future effects. . . which dovetailed right into future events per CEO comments. I questioned my decision to sell at $16, but I'm not buying back now at $5. This company could be at risk.

Jan 11 10:51 AM

[Jonas Elmer...:]

I would have to agree with you that WDC is another good looking stock right now. Aside from being bullish on hard drives, the company has awesome financials. You're right, WDC does score higher than STX on a number of metrics, but ultimately, it's Seagate's unbelievably low valuation that pushes it over the top.

If I were just picking "good stocks" WDC would likely have made the cut... unfortunately, two HDD manufacturers didn't make sense for the Rhino Stock Report's model portfolio.

Watkins is pressured... margins got hit hard in the last quarter (per the article), but I think that Seagate will be able to tighten their belt in the next six months.

I wouldn't take the company's downgrade too seriously for a long term position... even if you do, you could look at their upgrade by Dinesh Moorjani as an offsetting rating.

The market does suggest the stock is cheap right now for a reason, but it doesn't have to be a good one... We'll get our first glimpse on January 21 when they report earnings.

Jan 11 06:20 PM