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Seagate Technology PLC (NASDAQ:STX) reported fiscal second quarter results, which were decent. The growth numbers aren't attractive, and the valuation is less attractive than the growth numbers. On the other hand, the firm increased its operating efficiency during the quarter. But there was a significant decline in shareholders' equity.

Revenue came in at $3.5B with net income at $428 million. The share count declined to 336M from 347M. With free cash flow during the first six months of the fiscal year at $1.234B, FCF per share was $3.67. That said, the equity balance declined to $2.5 billion as the company repurchased $1.7B worth of shares during the first six months.

When I look at the fundamentals and P/B of 7.82, I can't be bullish on this company. I continue to view Seagate as the weak link in electronic storage.

Recent Developments

  1. STX announced that it is working with Lenovo (OTCPK:LNVGF) to deliver YOGA 2, a new multimode PC powered by Seagate's Laptop Ultrathin HDD.
  2. STX introduced the Backup Plus FAST portable drive, the world's first portable 4TB storage device.
  3. STX entered into a definitive agreement to acquire Xyratex (NASDAQ:XRTX), a provider of data storage technology, for $374 million. The transaction is expected to contribute $500-$600 million to revenue during fiscal year 2015.

Business Summary

Seagate Technology PLC is a leading provider of data storage products. Its principal products are hard disk drives, but the company also produces solid state hybrid drives, and solid state drives. Seagate's products are designed for multiple use cases, including (but not limited to) enterprise servers, mainframe and workstations, and client compute applications.

STX generates most of its unit shipments from OEMs and distributors in the Americas and Asia Pacific. While ASPs have been flat recently, Client Compute unit shipments trended lower. But Exabytes shipped trended higher. Quarterly Client Compute unit shipments could be in the low 30 millions during fiscal 2014 and 2015, which would weigh on revenues as ASPs remain flat.

Revenues increased 2% sequentially during the fiscal first quarter but declined relative to the year-ago reporting period. Gross margin and operating margin were flat sequentially. GAAP basic EPS increased 24% as the fiscal fourth quarter included a debt charge.

Generally, operating efficiency improved during the fiscal second quarter. The receivables turnover ratio increased from 8.49 to 8.73 and the working capital turnover ratio increased from 4.72 to 4.75. Total asset turnover was flat at 1.55. Operating efficiency was solid during the quarter.

The liquidity and solvency position diverged during the quarter. Liquidity was roughly flat from the prior quarter with the cash ratio at 0.95 and the current ratio at 2.15. The financial leverage ratio increased substantially from 2.54 to 3.57 as equity decreased. The solvency position is worth monitoring.

Profitability was roughly flat during the quarter relative to the prior quarter. The gross margin came in just below 28% with the operating margin declining to 12.6% and the net profit margin roughly flat at 12.1%. It was a solid quarter on the profitability front.

Revenue was roughly flat relative to the year-ago period and the prior period. Operating income declined significantly from the year-ago period ($555M v. $444M). But net income was flat relative to the first quarter. These were decent financial performance results but nothing to call home about.

STX should create wealth for me during the next 12 months. I would charge the company 8% for my equity capital. The company should be able to add value based on my discount rate.

Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in Seagate in light of their own unique circumstances.
  3. A decline the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for Seagate's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in Seagate.

Valuation & Portfolio Management

The share price of Seagate is in a bull market of primary degree as it has risen from $10 per share to just under $60. At this point, it is pretty safe to say that the rally is long in the tooth, from a technicals perspective.

There isn't much of a diversification benefit from investing in STX, relative to the S&P 500 (NYSEARCA:SPY). The correlation since 2009 is 0.93. Since 2011, the correlation is 0.97. And since 2013, the correlation is 0.95. All three correlations are statistically significant at the 95% confidence level, relative to zero correlation.

Thus, variations in the share price of the S&P 500 explains a substantial amount of the variations in the share price of STX. Since 2009, the portion of the variation in the share price of STX explained by the share price of the S&P 500 ranged from 87% to 95%. Consequently, forecasts for the share price of STX should include forecasts for the broader market.

Is STX likely to outperform the broader market? My model says, "yes." I place the chance of outperformance at 60%. Granted, that outperformance could mean STX declines less than the broader market.

Including the recently released results, STX is trading at 7.82 times book value. Factoring in the fundamentals of the company, STX should not be trading at a substantial premium to the market. But it is trading at a substantial premium to the market. The market is priced at 2.6 times book.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seagate May Be Overvalued