Seagate Technology: Long-Term Prospects Are Attractive

Seagate Technology (STX) supplies hard disk drives (HDDs) for the enterprise storage, personal computer, and consumer electronics markets. STX generates half of its sales in the Asia Pacific region, 26% in North America, and 24% in Europe.

Desktop storage drives accounted for half of fiscal Q2 unit volume. They include the Barracuda and DiamondMax product families of 3.5-inch drives with up to 2.0 terabytes (TB) of capacity delivered at up to 7,200 RPM. Mobile computing drives, sold under the Momentus brand name, accounted for 30% of unit volume. They are designed for notebook computers, tablet computers, and digital audio devices. They have up to 640 gigabytes (GB) of memory capacity and speeds of up to 7,200 RPM. Enterprise storage products were responsible for 9% of unit volume. They include 2.5-inch and 3.5-inch drives with up to 2.0 TB of memory and speeds up to 15,000 RPM. Product families include Pulsar, Savvio, Cheetah, Constellation, and Barracuda.

Finally, drives for consumer electronics produced 11% of unit volume. These drives are installed in digital video recorders, video game consoles, home electronic entertainment devices, and other consumer products.

STX also sells branded external backup storage devices, which are marketed under the Free Agent and Maxtor OneTouch brands.

Original equipment manufacturers generated 64% of fiscal 2009 net sales. Distributors and retailers accounted for 27% and 9%, respectively.

Demand for data storage hardware has been robust as more consumers create, share, and store increasingly rich digital content such as digital photographs, music, videos, and other multimedia files. The expanding availability of broadband Internet and increased emphasis on backing up data are also fueling demand. HDD volumes were historically tied to personal computer sales.

More recently, demand is being driven by consumer electronic devices.

The recession led to a dip in demand, an oversupply of product, and falling prices. The subsequent inventory correction resulted in supply shortages and a swift rebound in prices. These price increases along with cost cuts and a recent rebound in demand produced stellar profits. Fiscal Q2 net sales jumped 33.3% yearover-year to $3.03 billion. STX shipped 49.9 million units, up 35.8%. The gross profit margin surged to 30.49% from just 13.92% a year earlier. Pro forma net income was $543 million or $1.05 per share, easily beating the consensus estimate. GAAP net income was $533 million or $1.03 per share.

Investment risks include the weak economic climate and further deterioration in consumer and business spending trends, an oversupply of product due to improper demand forecasts, and the increasing popularity of solid state drives (SSDs). However, because SSDs, are significantly more expensive than hard disk drives they are not likely to pose a serious challenge in the near term.

Gross margins in fiscal Q3 and Q4 may fall from the fiscal Q2 level, but the full year figure should surpass management’s 22-26% target. The company is forecasting $2.9-3.1 billion in net sales for fiscal Q3 and 90-94 cents in per share earnings. Long-term prospects are attractive as digital content grows in popularity and broadband Internet connectivity expands.