Seagate Likely To Underperform

| About: Seagate Technology (STX)
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Summary

Seagate may benefit from increased global data storage needs.

In the March quarter, cloud demand could not offset PC demand decline.

At the current price Seagate is good for dividend investors.

Seagate Technology (NASDAQ:STX) is a maker of HDD (hard disk drive), SDD (solid state drive) and hybrid data storage devices. Seagate has done a great job returning cash to shareholders through dividends and buybacks, but it is working in a technology market segment where growth can be hard to come by.

March Quarter Results

After the release of Seagate's March quarter (fiscal Q3 2015) data before the market opened last Friday, the stock had a good day, closing at $57.43, up $1.27 during the day. Yet STX had hit a 52-week high of $69.40 back on December 23, 2014. Seagate reported a better quarter than many analysts had projected. But it was not a good quarter, and the following price rise does not indicate long-term strength. Rather, data for the quarter is reassuring that the industry is not collapsing and the dividend should be safe for quite some time.

Revenue in the quarter was $3.33 billion, which is sequentially down 10% from $3.70 billion, within the normal range of seasonality. But it was down 2% from the year-earlier quarter. Perhaps that's within the realm of normal statistical fluctuation, but it screams stagnation, not growth.

Net income was $291 million using GAAP, but $357 million non-GAAP. The GAAP number is down 26% y/y. The non-GAAP number is down 21% y/y. EPS was down about the same, to $0.88 GAAP and $1.08 non-GAAP.

Specific to the quarter, Seagate reported that the market was weaker than expected, particularly in Europe, where in addition to the long-term malaise the exchange rate has hurt demand in units and dollars. Global weakness was mainly in units shipped with or sold for PCs. Cloud and datacenter demand held up well.

Cash ended at $2.6 billion, with operating cash flow of $374 million and free cash flow of $215 million. But there's long-term debt of $3.9 billion. Despite the debt, cash returned to shareholders in the quarter included $176 million in dividends and $706 million in share repurchases.

Data Storage Trends

It is important to understand that this flattish revenue and down EPS is occurring while the need for data storage is growing rapidly. The problem is the hyper-competition with Seagate's main rival, Western Digital (NYSE:WDC). Both companies are rapidly introducing new technologies that allow more data to be put on a drive, driving down the cost per unit of data. So despite large amounts of video being stored in the cloud and in client devices, on a dollar basis annual demand is hovering near flat.

If the ability to increase data density on drives were to slow, that would be a long-term positive for both Seagate and Western Digital. On the other hand, my sense is that it is just as likely that cloud and client demand for storage space will slow at some point, leading to a further decline in the HDD industry.

The Dividend

The dividend of $0.54 per share will be payable on May 15 to shareholders of record on May 1. At Friday's closing price that worked out to 3.76% per share annually. That is a great return and it looks solid for years to come, given how operating cash flow exceeds the dividend payment.

Conclusion

I bought STX in 2012 at $23.13 per share, but my thesis was different then. Many analysts believed SSDs would wipe out HDDs in short order, leading to Seagate and Western Digital being wiped out. I looked at reality and decided that those analysts were wrong. I thought that if HDDs declined it would be gradual and that the HDD makers also would become major SSD players.

I called that correctly, but sold my STX shares in 2014 for an average of $59.45 per share. My analysis had not changed - the share price had. I like dividends, but I am ambitious enough to set goals of not just beating the S&P, but of beating the iShares Biotechnology ETF (NASDAQ:IBB). That requires that an undervalued stock I buy bounces up to a realistic value, or that I buy into growth stocks where the market is not fully appreciating future growth.

In other words, I thought there was alpha available in STX in 2012. Now there's just the dividend. It is a great dividend, way better than is available from U.S. government bonds, and with some up-side potential if data storage demand grows faster than expected.

I do own one storage company: Dot Hill (NASDAQ:HILL). As a microcap Dot Hill is riskier than Seagate, but it has been on a roll lately. Most recently it announced major extensions of partnerships with Quantum (NYSE:QTM) and Teradata (NYSE:TDC) and is guiding toward a good Q1 showing y/y growth. HILL pays no dividend, has a lot more risk and is emerging from hard times. If you want alpha, that's the sort of play where it might be found.

Disclosure: The author is long HILL.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.