Bad News from Seagate Technology Presents Opportunity in Western Digital

Includes: STX, WDC
by: James Cullen

Shares of hard drive makers Western Digital (NYSE:WDC) and Seagate Technology (NASDAQ:STX) sold off 3% and 6.2%, respectively, following a pre-announcement warning from Seagate Monday that revenues and margins would fall short of expectations.

In the case of WDC, I believe that investor pessimism is an unwarranted overhang from the poor fortunes Seagate is having – both stocks are down about 15% year-to-date, but Western Digital looks to be a stronger company and better investment, as it has superior operating margins (8.5% and increasing to Seagate’s 4.7% and falling), better growth opportunities (plans to expand into the fastest growing segments of data storage, namely consumer electronics, with the current consensus five-year looking too low), and a more attractive valuation (WDC trades for 4.6x EV/EBITDA and 0.587x EV/Sales, with STX at 9.3x EV/EBITDA and 1.18x EV/S despite having lower margins on those sales).

Further, if the leaner business model run by Western Digital begins to challenge Seagate in additional areas of the market, Seagate’s margins will be hurt even more than they already have – something that Western Digital appears able to afford, but not Seagate. Finally, Western Digital also has a large cash reserve nearing $800 million, which will give it more flexibility than the debt-carrying Seagate to make acquisitions, increase R&D spending, or pursue other activities to enhance shareholder value.

Although I’m not a chart reader, I can’t ignore the intraday pattern given Monday, with WDC hitting a low right near the open and proceeding to tentatively work higher the rest of the day. This might not be the absolute bottom, but with a conservative fair value estimate of $21 on WDC, I believe the current price in the $16 range provides an excellent time to consider entering a position.

STX/WDC 1-yr comparison chart

Disclosure: none