I wrote an article about Seagate Technology (STX) and Western Digital (WDC) this past December 17 when STX (now $34.80) was trading at $27.68 and WDC (now $51.18) was trading at $37.78. Several people have asked whether I still like them at current market prices; the answer is an emphatic, "yes." As I have said before, I would buy both of them to cover any risk that one or the other steals market share from its prime competitor. Because the two of them combined now control over 90% of the disk drive market, this strategy eliminates one important source of risk.
STX and WDC are similar in many ways: they each have a fiscal year which ends at the end of June, they each have recently acquired a large competitor (STX acquired Samsung's operations in late 2011; WDC acquired Hitachi's operations in March 2012) , they each have strong balance sheets, and they each are trading at very low multiples to earnings and cash flow. The table below provides Monday's closing price, current dividend yield, net balance sheet cash per share, trailing twelve months earnings per share and price earnings ratio (based on trailing twelve months earnings). Stock prices and current yields are derived from Yahoo Financial; earnings and balance sheet information is derived from each company's filings with the SEC.
As you can see, each of these companies is throwing off a lot of cash, and the cash output has continued nicely into fiscal 2013. The two companies have followed different strategies in deploying the cash which continues to gush over the transom each month. STX has emphasized share repurchases while WDC has built up balance sheet cash. WDC management has committed to devoting 50% of cash flow to a combination of dividends and share repurchases going forward so that more repurchases are likely to materialize.
For each company, fiscal 2013 started last July and, as of the financial statements released for the quarter ending December 2012, we were halfway through the fiscal year. The table below provides the dollar amount of share repurchases and the percentage reduction in share count over the first 6 months of fiscal 2013 based on each company's SEC filings and share count information on each company's website.
|Repurchases in Dollars||% Share Count Change|
STX was much more aggressive on the repurchase front and reduced its share count considerably in a short period of time. WDC was more conservative and has built up balance sheet cash, which, as noted above, is likely to be targeted at repurchases going forward.
Although many investors are lukewarm toward share repurchases and - at the same time - are enthusiastic about dividend increases, it is important to understand the relationship between the two. Share repurchases reduce share count, and thereby make future dividend increases less expensive. Buying shares back when a company's stock is trading at a cheap price is a great way to set the stage for generous dividend increases in the future.
The coming quarterly reports of each company should be interesting. STX paid extra dividends in December in anticipation of the tax law change and skipped first quarter dividends (which were essentially prepaid in December). That means that STX likely had extra cash in the most recent quarter; it will be interesting to see how it was deployed.
The next few quarters will tell us a lot about WDC and STX. The quarter ending March 31, 2013, will be the first quarter in which we will be able to see a meaningful year over year comparison of STX, including the Samsung acquisition. For WDC, we will have to wait until the quarter ending June 30, 2013, for similar year over year comparison of WDC including the Hitachi acquisition. We are also now operating in a market with much less competition than we have had in the past, and it will be interesting to see how prices hold up.
The negative thesis on WDC and STX has generally been that they are each tied to the PC market and that the decline in PC sales will be devastating to them. On the other hand, there is significant evidence that they will profit from the ever expanding need for cheap storage at data centers. In this regard, WDC has increased enterprise sales from 1.7 million units to 6.6 million units on a year over year quarterly basis as of the last quarter (based on information on its most recent quarterly earnings report filed with the SEC). The financial impacts of these changes are likely to be revealed in the next several quarters.
WDC and STX are now priced for the worst possible expectations in terms of income and cash flow. Pundits have been predicting the demise of these companies for a very long time, and they just keep cranking out cash flow. At this point, the purchase of these two stocks offers one of the better risk reward trade offs in the market today.