Seagate Technology PLC (STX) makes electronic storage devices. Most of the company's sales come from the Asia region. Seagate has three primary operating segments: Enterprise, Client Compute, and Client Non-Compute.
Currently, Seagate is trading off of its recent high. Is it a good time for investors to accumulate shares?
To determine if it is a good time to accumulate shares, I will analyze the risks, recent developments, business profile, financial performance forecast, and valuations.
Seagate has had some periods of outperformance and some periods of underperformance, historically. That could mean that Seagate will continue to outperform, or Seagate will underperform.
In my opinion, Seagate will face weakness from declining PC sales, but that will be partly offset by demand stemming from cloud computing and the introduction of a product line for tablets. Further, I think the Enterprise and Client Non-Computing segments will grow, but that will be offset by a lower average selling price. Thus, I think the company faces some top-line challenges in fiscal 2014.
All of that said, based on my models, Seagate is fairly valued; I will consider purchasing shares if the share price falls 15+% (assuming the valuation stays the same).
- From time to time the industry has experienced periods of imbalance between supply and demand. To the extent that the disk drive industry builds capacity based on expectations of demand that do not materialize, price erosion may become more pronounced.
- A significant portion of Seagate's success has been a result of increasing market share at the expense of competitors, particularly in enterprise markets. That said, the market share for products can be negatively affected by customers' diversifying their sources of supply as competitors enter the market for particular products, as well as by Seagate's ability to ramp volume production of new product offerings.
- Seagate purchases components from a limited number of suppliers, which gives those suppliers bargaining power and could adversely impact Seagate's results of operations.
- The increases in the areal density of disk drives may outpace customers' demand for storage capacity.
- The increasing demand for cloud compute services is decreasing consumer demand for storage capacity.
- The share price will continue to be volatile and investors could lose a portion or all of their investment.
Seagate announced it is shipping the world's fastest hard drive, the Seagate Enterprise Turbo SSHD. The Enterprise Turbo SSHD combines the capacity of a hard drive with solid-state flash, enabling high-speed performance for mission critical data.
Seagate is a leading provider of electronic data storage products. Its principal products are hard disk drives, commonly referred to as disk drives, hard drives or HDDs. Hard disk drives are devices that store digitally encoded data on rapidly rotating disks with magnetic surfaces. Disk drives continue to be the primary medium of mass data storage due to their performance attributes, high quality and cost effectiveness.
Seagate produces a broad range of electronic data storage products including HDDs, solid state hybrid drives (SSHD) and solid state drives (SSD), which address enterprise applications, where its products are designed for enterprise servers, mainframes and workstations; client compute applications, where its products are designed for desktop and notebook computers; and client non-compute applications, where its products are designed for a wide variety of end user devices such as digital video recorders (DVRs), gaming consoles, personal data backup systems, portable external storage systems and digital media systems. In addition to manufacturing and selling data storage products, Seagate provides data storage services for small to medium-sized businesses, including online backup, data protection and recovery solutions.
The principal markets served by the electronic data storage industry are: Enterprise storage, client compute, and client non-compute.
Enterprise storage are those solutions which are designed for mission critical and nearline applications. The market for mission critical enterprise solutions could continue to be driven by enterprises moving network traffic to dedicated storage area networks in an effort to reduce network complexity and increase energy savings. Further, the market for nearline applications, those which include storage for cloud computing, content delivery and backup services, could continue to grow and drive demand for high capacity, energy efficient solutions.
Client compute applications are solutions designed for desktop and mobile compute applications. The client compute market could continue to be driven by demand for cloud computing storage solutions. Economic growth and the increasing quantity of digital content should increase demand for client compute solutions.
Non-compute applications are solutions designed for consumer electronic devices and disk drives used for external storage and network-attached storage [NAS]. Disk drives designed for consumer electronics are primarily used in DVRs and gaming consoles. The increase in the quantity of high definition content could drive demand for Seagate's non-compute solutions.
In terms of product offerings, Seagate manufactures solutions for the enterprise storage, client compute, and client non-compute markets. The firm offers a broad range of HDDs, SSHDs, and SSDs that vary based on capacity and speed. These products are sold to OEMs, distributors and retailers, with OEMs comprising the largest portion of sales. Dell Inc. and Hewlett-Packard Company accounted for 23% of sales in fiscal 2013.
Seagate's primary competitors in the disk drive industry are Western Digital Corporation and Toshiba Corporation. Further, Seagate competes with companies that provide alternative storage technologies such as flash memory and SSDs used in mobile applications such as tablets, notebooks and lower capacity handheld devices in addition to SSDs used in enterprise applications for rapid processing and high volume transactions.
Management believes that continued growth in digital content requires increasingly higher storage capacity in order to store, aggregate, host, distribute, manage, backup and use such content. Management also believes that as architectures evolve to serve the growing commercial and consumer user base throughout the world, the manner which hard drives are delivered to market and utilized by our customers will evolve as well.
Seagate believes that in the foreseeable future the traditional enterprise and client compute markets that require high capacity storage solutions, as well as the data intensive client non-compute markets, will continue to be best served by hard disk drives due to the industry's ability to deliver cost effective, reliable and energy efficient mass storage devices. Furthermore, the increased use of client non-compute devices that consume media rich content streamed from the cloud increases the demand for high capacity disk drives in nearline applications.
The firm has experienced, and expects to continue to experience, intense competition from an independent disk drive manufacturer and a captive manufacturer. The term "independent" in this context refers to manufacturers that primarily produce disk drives as a stand-alone product, such as Western Digital Corporation, and the term "captive" in this context refers to a manufacturer who through affiliated entities produces complete computer or other systems that contain disk drives or other electronic data storage products, such as Toshiba Corporation.
The captive manufacturer is a formidable competitor because it has the ability to determine pricing for complete systems without regard to the margins on individual components. As components other than disk drives generally contribute a greater portion of the operating margin on a complete computer system than do disk drives, the captive manufacturer does not necessarily need to realize a profit on the disk drives included in a complete computer system and, as a result, may be willing to sell disk drives to third parties at very low margins. The captive manufacturer is also a formidable competitor because it has more substantial resources than Seagate does. To the extent that Seagate is not successful competing with the captive or independent disk drive manufacturers, the results of operations will be adversely affected.
Seagate also experiences competition from other companies that produce alternative storage technologies like flash memory, where increasing capacity, decreasing cost, energy efficiency and improvements in performance ruggedness have resulted in competition with its lower capacity, smaller form factor disk drives. While this competition has traditionally been in the markets for handheld consumer electronics applications, these competitors have announced solid state drives for tablet, notebook and enterprise compute applications. Certain customers for both notebook and enterprise compute applications are adopting SSDs as alternatives to hard drives in certain applications.
At the end of the fiscal 2013 fourth quarter, there was $903 million left in the share repurchase program. In an open market share repurchase program, cash is received by shareholders with concurrent sell orders. The repurchase program may be a sign that management believes that the shares are undervalued in the market place. Management could also be trying to offset the dilution of investors' interest because of the exercising of employee stock options. The share repurchases have been sufficient in size to reduce the amount of shares outstanding.
A share repurchase program decreases assets and shareholders' equity and increases leverage. Also, earnings per share increases. The book value per share of Seagate declines with share repurchases.
One of the biggest threats to this company is the lack of product offerings for the tablet and smartphone markets. But, Seagate believes that sales of drives for tablets will commence in the third calendar quarter and continue on from there. Thus, the company's new tablet offering could offset what I expect to be a less than stellar fiscal 2014.
I think that the impact of declining PC sales will be seen in fiscal 2014. The PC sales decline significantly impacted PC manufacturers in calendar 2012 and 2013. The flood in Thailand offset the impact of the PC sales decline, through a higher HDD ASP. I think Dell and HP will order fewer solutions from Seagate in the company's fiscal 2014, which will adversely impact revenues and results of operations.
For example, if the acquisition of Samsung's HDD business occurred in fiscal 2012, Seagate's consolidated revenue would have been $16.1 billion and would have declined to $14.4 billion in fiscal 2013. The acquisition masks the impact of declining revenues because of price erosion and less client compute unit shipments. Compute units sold, the PC solutions unit, declined, while non-compute units sold increased. Enterprise unit shipments were roughly flat.
Financial Performance Forecast
In this section, I will forecast the unit shipments and average selling price. Also, I will include a forecast of revenue, operating income and net income. Finally, I will discuss the firm's use of cash.
I'm looking for 31 or 32 million Enterprise unit shipments. I think the Client Compute segment will be adversely impacted by PC sales, but those declines will be offset by tablet and cloud computing product orders. Thus, I'm forecasting a 3% to 7% decline in unit shipment for the unit, or 140 to 147 units sold in fiscal 2014. Client Non-Compute shipments should increase to 50 units. I'm looking for an ASP of $58. Thus, revenue should be in about the $12.85 billion to $13.25 billion range. Fiscal 2013 revenue was $14.35 billion.
I think the operating margin will be about 15% and the net income margin will be about 13%. So, operating income would be in the $1.93 billion to $1.99 billion range. Net income would be in the $1.67 billion to $1.72 billion range. Margins tend to be somewhat volatile due to changes in the cost of revenues. But, unless something changes, I think the margins will be flat compared to fiscal 2013 and roughly inline with fiscal 2010.
In terms of cash usage, I think Seagate is returning too much cash to investors. Seagate should be reinvesting more of its cash into its business. Near term, returning cash could increase shareholders' value; long term, returning so much cash could make the business less competitive.
I don't see solvency being an issue near term, but the company did report $6.07 billion of contractual cash obligations and cash of $2.2 billion.
I'm going to use a discounted cash flow model and a multiplier model to value common equity shares of Seagate. The current market price is $41.34.
I think the dividend will increase to $1.66 in fiscal 2014. There are a substantial amount of assumptions that go into a discounted cash flow model. That said, based on the results of my model, the fair value of the common equity shares is $37.35, which is 10.7% less than the market price.
Next, I will use the justified value to determine the fair value. My EPS forecast is just below the mean forecast of the street, but well within the range. That said, based on my model, I estimate the justified PE as 7.65. Thus, the fair value of the common equity shares using this model is $48.65.
Now, I will use the historic average valuations to determine a fair value. The fair value using the price/earnings ratio is $51.52. The fair value using the price/book ratio is $25.37; using the price/sales ratio, the fair value is $22.55 and the price/cash flow fair value is $44.52. The average of those four fair values is $35.99.
The average of the three fair value methods, and the fair value of the common equity shares, is $40.66. Consequently, Seagate is fairly valued at $41.34. So, I would use a 15+% decline in the share price to accumulate shares.