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Summary

  • Forecasting flat to down fiscal 2014 revenue.
  • Seagate is fairly valued at $50 per share.
  • The technicals suggest that this is a "dip-to-buy."

Seagate Technology PLC (NASDAQ:STX), the hard disk drive provider, reported first half of fiscal 2014 results that disappointed investors. Sales of the firm are slumping as consumers elect to purchase mobile devices that are manufactured with solid state drives rather than tradition hard disk drives. While the pace of the decline in PC sales has slowed recently, STX should continue to be adversely impacted by the shifting technology landscape for the rest of fiscal 2014.

Looking ahead to fiscal 2015, revenue is forecasted to increase 3% as client compute sales stabilize and the firm builds more of presence in SSDs and SSHDs. Also, STX is forecasted to continue to generate sizeable cash flows, which is forecasted to result in significant share repurchases and an appreciable increase in the dividend.

With that stated, based on the forecasted fundamentals, STX is fairly valued. Investors looking for exposure in electronic storage should prefer SanDisk (NASDAQ:SNDK), based on its valuation.

Recent Developments

  1. The company introduced its Video Surveillance Systems Solution Center.
  2. Jamie Lerner joined the company as President, Cloud Systems and Solutions. Lerner most recently held the position of Senior Vice President and General Manager of the Cloud and Systems Management Technology Group at Cisco Systems.
  3. Seagate unveiled the Seagate Surveillance HDD, which is a 3TB HDD.
  4. The organization was upgraded to Outperform by RBC.

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.

The hard disk drive industry is concentrated with two firms supplying almost all of the market. But the pricing power of the two firms is limited as, for the most part, buyers are concentrated and end users are constrained by income. The threat of new entrants into the hard disk drive industry is low, but firms with alternative technology, such as NAND, limit the profitability of hard disk drive manufacturers. Consequently, without capital distributions, STX's abnormal earnings would likely be minimal.

2011-06

2012-06

2013-06

2014-06E

2015-06E

Revenue

$10,971

$14,939

$14,351

$14,200

$14,650

Gross profit

$2,146

$4,684

$3,940

$3,976

$4,395

Operating income

$806

$3,108

$2,091

$1,846

$2,784

Net income

$511

$2,862

$1,838

$1,704

$2,491

Diluted EPS

$1.09

$6.49

$4.81

$4.97

$7.98

Fiscal 2013 revenue was soft on lower ASPs and a weak client compute environment. The weakness in ASPs and client compute is expected to continue through fiscal 2014. But in fiscal 2015, I think we see a moderate rebound in client compute with continued strength in enterprise and non-client compute. The key risk to the forecast is the ASPs, but ASPs should be boosted by a product mix that includes larger volumes of hybrid and pure SSDs. For fiscal 2015, revenue is forecasted to increase 3% with gross margin expansion stemming from operating leverage. Consequently, fiscal 2015 EPS is forecasted to increase almost 61% as share repurchases decrease the outstanding share count.

2011-06

2012-06

2013-06

2014-06E

2015-06E

Ending financial leverage

3.75

2.89

2.64

3.5

3.4

Debt-to-capital

0.59

0.45

0.44

0.59

0.58

Quick ratio

1.34

1.31

1.48

--

--

Current ratio

1.86

1.86

2.07

--

--

After declining, the financial leverage ratio started to trend higher as STX increased the level of debt relative to assets. It appears management is comfortable with the debt-to-capital ratio in the 0.45 to 0.60 range. In my opinion, that is an aggressive use of leverage. But the firm has ample liquidity.

2011-06

2012-06

2013-06

2014-06E

2015-06E

CFO

$1,264

$3,262

$3,047

$2,982

$3,077

Capex

$843

$636

$786

$650

$750

FCFF

$633

$2,865

$2,473

$2,526

$2,521

FCFE

$1,368

$1,956

$2,023

$2,332

$2,327

Share repurchases

$822

$2,426

$1,654

$1,490

$1,455

Dividend paid

$74

$372

$518

$600

$700

Cash flow from operating activities is expected to remain at roughly $3B with capital expenditures of roughly three quarters of a billion. Consequently, the forecast is for free cash flow to the firm of about $2.5B. Free cash flow to equity should continue to trend higher as the firm issues debt. Free cash flow to equity is forecasted to be spent on share repurchases and dividends.

In conclusion, the forecast is for continued strong financial performance. But leverage poses a long-term risk, especially as consumer preferences shift to SDDs and Western Digital (NASDAQ:WDC) increases its presence in the mission-critical enterprise segment. Also, price erosion pressures continue to pose a threat to cash flows. But industry consolidation and increasing quantities of storable electronic data provide a tailwind.

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 STX in light of their own unique circumstances.
  3. A decline in 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 STX'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 STX.

Portfolio & Valuation

(click to enlarge)

STX is in an intermediate term decline as part of a primary degree bull market. Simply stated, this is a "dip-to-buy."

Monthly expected return

Quarterly expected return

Monthly standard deviation

5%

13.55%

15.65%

Intrinsic value estimates

Base case forward valuations

Optimistic

$66.24

P/E: 10

Base case

$49.68

P/S: 1.2

Pessimistic

$33.12

P/BV: 6.76

P/CFO: 5.71

To value STX, a fundamentals based dividend discount model was used, which applied the 2014-EPS forecast to the justified PE. Consequently, the model found that STX is fairly valued. STX was charged a premium for its aggressive use of leverage, and the long-term growth rate is estimated as being 6%. At the base case intrinsic value, STX would be trading at 10 times estimated 2014 earnings and 1.2 times estimated 2014 sales.

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: Decent Fundamentals But Fairly Valued