Seagate Technology (NYSE: STX) has seemed like one of the best stocks over the last 12 months, as evidenced by its share price. However, it has a lot of haters out there for various reasons, including the decline in PC demand. Are these criticisms correct, especially after the most recent warnings from Hewlett-Packard (NYSE: HPQ), Dell (NYSE: DELL), and Intel (NYSE: INTC)? Also, the trends toward SSDs are another reason analysts and investors are staying away from this company. The question comes down to: are these criticisms merited?
We are a leading provider of electronic data storage products. Our 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, cost effectiveness and energy efficiencies. We produce a broad range of electronic data storage products addressing enterprise applications, where our products are designed for enterprise servers, mainframes and workstations; client compute applications, where our products are designed for desktop and notebook computers; and client non-compute applications, where our 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 disk drives, we provide data storage services for small- to medium-sized businesses, including online backup, data protection and recovery solutions.
(Source: STX 10-K)
Clearly, management outlines that its products are geared toward HDDs. However, if you look past the basic description in the 10-K, one notices all of the products and markets that the company is in. These include enterprise storage, SSDs (Pulsar Family), and PCBAs. Oh wait? STX has SSD exposure? The answer to this is clear, especially as they finish up the full-acquisition of LaCie.
Technology is what the world circles around, and the sector that has been a quality investment over the last 3 years especially. The debate on the radio station I listened to yesterday was "What would you do for an iPhone 5?" Technology is all around us and constantly changing. AAPL launches a new phone every year, and Samsung has increased this turnaround speed to about 6-9 months! Being up-to-date is key in the tech world.
HDDs are perceived to be a thing of the past. There are many advantages and disadvantages to this type of product, which is being usurped by flash memory and SSDs. The HDD industry itself is consolidated between three companies: Western Digital (NASDAQ:WDC), Seagate, and Toshiba. The market shares are 45%, 42%, and 13%, respectively. Since the 2011 Thai floods, STX was able to steal away market share as it was not affected as much as others. Prices for HDDs have remained higher than average, leading to gains in gross profit margins and overall profitability. WDC before its recent shareholder meeting on 9/13/12, thought margins would contract soon, but in the meeting WDC released that it was not seeing that margin contraction. This is positive for the HDD industry. WDC also released that it will not compete on a market share basis in its most recent earnings call. The HDD industry hit another positive this year with a record amount of FCF, which is expected to continue to grow.
The other 800 pound gorilla in the room is other technology, from smartphones to tablets. Though these devices have cannibalized sales of PCs, they cannot fully replace the market at the current technology. Have you ever tried writing a full length report with a tablet or a smartphone? Good luck! Reports, term papers, and capacity in regards to multi-tasking are clear advantages of PCs. One can type a report with much more ease and speed on a PC. The death of the PC still is not here. That is evidenced by the growth in sales for MacBooks, Toshiba, and Lenovo PCs. The companies being hurt are the former champions of the PC business, namely STX's main customers: HPQ and DELL. HPQ and DELL aren't as flashy, up-to-date, or the social trend in the current world. This may hurt STX though given the percentages of revenue received from them.
I happened to be sitting in my MBA class yesterday. I looked around as everyone had their laptops out. You should note the keyword in that last sentence: laptop. Out of the roughly 25 students in that class, only 1 had a tablet. The student did not even use it in class, even though there was a PowerPoint presentation taking place. The brands of laptops were HPQ, Samsung, Dell, and Toshiba. There was only 1 Mac that I could see. This was an unbiased sample that I just happened to notice, and may very well be different than most other classes but something I am willing to take criticism on. Another problem within the PC world that I could see and notice right away was the quality of the PC itself. PCs, though bulky, are quality machines and greatly improved since the 1990s. The rule was that a consumer would have to replace their laptop every 4-5 years, given the new technology and faster speeds of the newer PCs. However, this is not the case. My current Toshiba laptop of over 5 years is still running strong. The only problem I had with it is I had to replace the battery just recently. These machines are not getting replaced as fast as they used to because of what they can still do and the amount of storage capability.
HDDs vs. SSDs - "Gunfight at the O.K Corral":
Obviously, the debate of the fate of PCs comes down to flash memory/SSDs against HDDs. Most other forms of technology run off of flash memory. As noted, this will eat away at the market for PCs but it cannot replace them due to the functionality of the products. Here are some of the differences and truths between HDDs and SSDs:
|Start-up||About Instantaneous||Several seconds due to power need|
|Random Access Time||0.1 milliseconds||2.9 to 12 milliseconds|
|Data Transfer Rate||Max: 100 MB/s - 600MB/s, depending on the disk; Reduced when smaller blocks are accessed||Roughly 140 MB/s|
|Noise||Basically silent||Moving parts = more noise|
|Temperature||Do not require special cooling; tolerates higher temperatures||Temperatures above 95F can shorten life of HDD; Reliability compromised at 131F|
|Weight & Size||Weigh as much as HDD due to enclosure||-|
|Reliability & Lifetime||Fails after limited # of times it can erase memory; firmware bugs are current common problem for data loss||Subject to potential mechanical failures from wear and tear over time|
|Secure writing limits||NAND flash can't be overwritten, leading to security, encryption, and accessibility concerns||Can overwrite data directly on the drive|
|Cost/Capacity||$0.65/GB||3.5": $0.05/GB; 2.5": $0.10/GB|
|Storage Capacity||Up to 2 TB but usually 64-256 GB||Up to 4 TB and growing|
|Read/Write Performance||Less expensive SSDs have significantly lower write speeds than read; high performers are in-line||Slower write speeds than read|
|Free Block Availability||Write performance significantly impacted by availability of free & programmable blocks = slower performance potentially||Not affected|
|Power Consumption||Require 1/2 to 1/3 less power; high-performance DRAM SSDs require as much as HDDs||0.35-20 watts|
Rise of the Solid State Hybrid Drive
Did anyone ever consider in this tech-advanced world, that a company would conceivably combine a SSD with an HDD? STX is the major player in the solid-state hybrid drive (SSHD), which combines a SSD with an HDD. A SSHD integrates a cache to use non-volatile memory or a small SSD, which will increase the speed of the reads and writes. STX has the Momentus XT 7200 RPM 2.5" drive that incorporates the two drive types. The system boot time was 41% faster than traditional HDDs, while SSDs are only 44% faster. The SSHD also offers decreased power consumption and improved reliability.
The shopping experience for many is looking at what is on clearance or heavily marked down. The chart below shows the P/E (excluding un-ordinary items), EV/EBITDA, PEG, and P/S for STX, and the S&P 500's P/E (Source: Capital IQ, as of 9/20/12):
As shown, the company trades at a discount to itself historically and well-below the S&P 500. That would normally lead one to look at the PEG ratio or expected EPS growth measures. STX is expected to grow about 20% in this fiscal year, driven 66% by buybacks due to its low valuation and large FCF. Management has said that it will reduce shares outstanding to 350M by the end of this calendar year and to 250M by sometime in 2014. The PEG is also well below 1, showing the expected growth to the P/E. Even looking at a non-price metric like EV/EBITDA, STX appears undervalued even to itself!
The present value of growth opportunities is a metric not commonly used. It tells an investor the expected growth by the market given the stock price currently. The formula is price equals EPS/required rate of return plus the expected growth (P = EPS/r + g). This can be done from a forward standpoint or ttm, with the share price based on a inter-day price of $29.70 on 9/20/12:
|EPS/r||$ 59.00||$ 63.73|
|Price - EPS/r||($29.30)||($34.03)|
|g as % (PVGO)||-98.65%||-114.57%|
The PVGO can signal that a company is not going to experience any more growth or that it is undervalued if the PVGO is lower than either peers or 0%. With a negative PVGO as a percentage, STX is clearly undervalued given that the market is expecting growth out of STX already! Clearly, there is value for investors in STX based on PVGO.
My Own Valuation
As I've pointed out in many comments on other SA articles, valuations are always wrong and are opinions. For my WACC, I used 11% as it is the expected return of the overall market over the last 10 years on average. It is an unbiased approach and may lead to criticism but it is my opinion on what a discount rate should be about for this kind of company. My valuations consist of various methods, including a DCF, DDM, and Market Multiples. For each of these methods, I use a bear, base, and bull case in order to evaluate the company thoroughly. Within the DCF model, I assumed a 2% growth and increasing COGS as a percentage of revenue. My terminal values for my bear, base, and bull cases were approximately $12.8B, $15.1B, and $17.3B (the market cap is at $11.55B right now and debt is approximately $2.86B). The following chart is what I got for price targets based off of my analysis:
|DCF||$ 27.50||$ 37.51||$ 46.59|
|DDM||$ 33.36||$ 37.75||$ 39.22|
|EV/EBITDA||$ 35.05||$ 40.92||$ 47.40|
|P/E||$ 35.70||$ 40.56||$ 42.19|
|P/S||$ 31.49||$ 34.38||$ 38.91|
Why Should An Investor Own?
STX has come back from a high of $35.71 just a few weeks ago. It held its recent shareholder conference on 9/21/12 and will announce earnings in October. In the conference, it noted that revenue will be down slightly compared to previous estimates, but not as bad as analysts had forecasted. It also hinted at another acquisition in the coming year (probably a SSD play as management has said before) by setting aside FCF for such an acquisition. Why do I think you should own it?
- Exposure to both HDDs and SSDs, as well as the SSHD technology to incorporate both
- PCs aren't dead - just ask the college kids who will one day be in business. Tablets and smartphones are great pieces of technology, but cannot replace a PC completely yet.
- Industry consolidation in recent years has left STX with a 42% market share.
- Geographic diversity of STX compared to peers.
- Returns 85% of FCF to shareholders. WDC just implemented a 50% FCF return to shareholders, showing value lies with STX over WDC.
- Stock is on sale from a multiple and growth basis.
- PC decline is already baked into the stock price, as evidenced by a negative PVGO and a strong pullback in shares.
- HDDs provide massive storage capabilities compared to SSDs. This gives companies like STX an advantage with cloud-storage providers.
- EPS is expected to grow about 20% this fiscal year, as management returns FCF to shareholders.
- At a +4% dividend yield, low payout ratio, and recent increase in the dividend, this stock has support. One can quote David Einhorn all they want, but the reason to own this stock is clear.
- Strong potential upside given a $38 price target. At the current price of $29.70, this provides for 36.22% upside and over 40% if you include the 4% yield.
- For the 'technicians' out there, STX typically bounces off of its 100 day MA strongly. The 100 day MA is $28.33 right now.
Additional disclosure: I am not trying to boost up my own stock return, even though I am long in it. I've already made a strong gain on this position and would look to buy more if it passed below a certain level that I deem acceptable. Thank you.