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Summary

  • Demand for the company's products will in part be driven by cloud-service providers and big data analytics.
  • The shares are currently fairly valued in the market.
  • The technicals are bullish with the intermediate trend being bearish and the primary trend being bullish.

Seagate Technology PLC (NASDAQ:STX), the hard disk drive manufacturer, reported less-than-stellar fiscal third-quarter results. Revenues were adversely impacted by unit shipments in the client compute segment and an overall lower average selling price. Also, the guidance that management provided suggests revenues are going to come in about $500 million below my forecast for the full year. On the bright side, the profitability margins are flat relative to the prior year, and the substantial share repurchase program is cushioning the results of operations on a per share basis.

Looking forward, there is seasonal strength expected in the back half of the calendar year. Also, the acquisition of Xyratex is accretive to the results of operations; thus, Xyratex is expected to increase fiscal 2015 results relative to what they would have been. On the enterprise side, Seagate is planning to release an 8-terabyte drive that will likely be consumed by enterprises seeking solutions to the problems posed by big data, and the shift to the cloud. I expect the pace of unit shipments decline in client compute to improve in fiscal 2015. Consequently, overall the fundamentals are bullish.

With that stated, at $50 per share, Seagate is fairly valued based on my estimated intrinsic value of $48 per share. Investors should accumulate shares below their intrinsic value.

Recent Developments

  1. Seagate is shipping the Enterprise Capacity 3.5 HDD v4, which is a 6 TB drive.
  2. The acquisition of Xyratex Ltd (NASDAQ:XRTX), a leading provider of data storage technology, was completed. Xyratex is expected to add $500-600 million of revenues.

Analyst's Note

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.

Taking a high-level perspective, there is demand for traditional storage solutions that is coming from cloud-service providers. The client compute market remains slightly down to flat. There is demand for high-performance drives emanating from transactional operations. Video surveillance and higher definition media are increasing storage requirements. Lastly, there is increasing demand to store structured and unstructured data. Simply stated, consumer storage requirements are relatively soft, but enterprise storage requirements are a source of strength.

For the year ending (in millions of dollars except per share data):

2013-06

2014-06E

Revenues

14351

13800

Gross profit

3940

3864

Operating income

2091

1794

Net income

1838

1656

Diluted EPS

4.81

4.83

The fiscal third quarter brought with it another set of disappointing results; previously, I was forecasting revenues of $14.2 billion, which is roughly flat with the prior year, but now I'm lowering my estimate to $13.8 billion. Revenues for the full year would be down about $500 million at $13.8 billion. The lower than forecasted revenues are attributable to weakness in client compute and softer ASPs. Client compute unit shipments declined just less than 8% y/y. Also, client non-compute has been a little weaker than I anticipated. The profitability margins were in line with my forecast. The table above includes the revised forecast.

The liquidity and solvency positions are tracking in line with my forecast. Seagate is financed primarily with debt capital at this point, as the level of debt exceeds the level of equity. Management shows a tendency to grow the business through organic innovation. Also, over the last 10 quarters the debt as a percentage of assets increased from 30% to 40%. Granted the current costs of debt financing are extraordinarily low.

There were revisions to the cash flows estimates, which emanate from the revenues revision. I'm now expecting $2.9 billion of cash flow from operations. Free cash flow to the firm is expected to coming in at $2.44 billion, and free cash flow to equity is forecasted to be just shy of $3 billion. The share repurchases were considerably larger than I expected for the fiscal year; I was expecting $1.5 billion of share repurchases and repurchases could total roughly $2 billion to $2.2 billion. Though the quantity of cash flows is moving in the wrong direction (shrinking), the absolute level of cash flows is appreciable.

The client-compute market may remain relatively weak for an extended period. But Seagate is expected to continue to earn more than its cost of capital. Also, the firm controls almost half of the electronic data storage industry, which is expected to continue to grow for the foreseeable future. Price erosion is a key risk to the outlook, but prices are expected by management to remain roughly flat.

General 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 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)

The technicals remain bullish. STX is in a bear market of intermediate degree and a bull market of primary degree. The two preferred scenarios are: this a dip-to-buy before a rally to a higher high, and this is the beginning of a trading range. Either way, for now, I'm bullish on STX, based on the technicals.

Monthly expected return

Quarterly expected return

Quarterly standard deviation of returns

5%

13.96%

27.08%

Intrinsic value estimates

Base case forward valuations

Optimistic

$64.37

P/E: 10

Base case

$48.28

P/S: 1.2

Pessimistic

$32.19

P/BV: 6.76

P/CFO: 5.71

The base case intrinsic value was lowered from $49.68 to $48.28 as the outlook for earnings deteriorated. At $50.50 per share, STX is slightly overvalued. Also, the forward valuations are roughly in line with the 5-years average valuations.

Source: Seagate: Why You Should Accumulate On Dips