Stumped over Seagate
Keith is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Why is Seagate (NASDAQ: STX) priced so low? Sure, certain stocks become undervalued from time to time in the natural ebb and flow of the financial world. I’m stumped, though, as to why Seagate isn’t trading higher – much higher. Either I am totally missing something or this stock presents a fantastic value right now. Let’s examine Seagate from three perspectives to see if I’m missing something here:
- Competitive Landscape
Seagate is cheap any way you look at it. It has a trailing P/E of 5.97 and a forward P/E of only 2.8. Discounted cash flow analysis reflects an intrinsic value of $42 per share, indicating a nearly 60% discount for the stock.
The company is also sitting on a cash stockpile of over $2 billion. It has already used some of its cash to buy back shares and recently announced additional buybacks totaling $2.5 billion. A buyback of that size amounts to over 22% of the company’s current market cap.
Is Seagate making any money? Lots. Revenue for the past 12 months topped $13 billion. The company’s profit margin is nearly 15% with solid earnings. Companies can manipulate earnings, though. Any astute investor knows to check out the cash flow. There are no skeletons in that department, either. Levered free cash flow for the last 12 months is around $761 million with operating cash flow over $2 billion.
Some stocks deserve low valuations because of massive debt that threatens the viability of the company. Seagate does have debt totaling $2.86 billion, but that level is not excessive - especially when you consider the company’s cash on hand. Seagate should have no problems servicing its debt.
So the financials look good, but those numbers reflect snapshots and don’t give a perspective on growth. Seagate’s growth is probably weakening, right? Wrong. Revenue for the most recent quarter grew over 65% compared to the same quarter last year. Earnings grew by over 1,132%. I’d call that pretty strong growth.
Maybe the stock is priced so low because no one expects continued growth. That makes sense, except the growth projections look great. The consensus of analysts covering Seagate is for the following earnings growth:
- Next quarter 726.5%
- Next year 32.5%
- Next 5 years per annum 37.94%
Of course, analysts can be wrong. In fact, they have been wrong about Seagate’s earnings routinely. However, they have been too pessimistic rather than too optimistic. Take a look at Seagate’s earnings estimate beats over the past few quarters.
Considering the macro trends that should benefit the entire data storage industry, I don’t think the analysts are being too rosy in their outlook. Microsoft rolls out Windows 8 this year. Enterprises are requiring more cloud-based storage. Legal and regulatory requirements are forcing companies to retain more data than ever before. All of these are drivers for Seagate’s continued growth.
Seagate’s PEG ratio based on 5-year expected earnings growth currently stands at 0.10. Earnings growth projections would have to be horribly off for the stock to not increase dramatically. Even if we assume the company will only grow at the annual rate that it has the past 5 years (8.13% per year), Seagate’s PEG would only be 0.45, still implying a steep discount.
There is no question that Seagate operates in a very competitive industry. Its primary competitors in the hard disk drive (HDD) space include Western Digital (NASDAQ: WDC) and Toshiba.
Seagate’s 2011 agreement to acquire Samsung’s HDD business gives Seagate a market share around 40%. Western Digital, with its merger of Hitachi’s HDD segment, has nearly 48% of the market. The HDD market has basically evolved into a duopoly with Toshiba in a distant third place.
The larger threat to Seagate is from solid state drive (SSD) manufacturers. While most PCs and enterprise servers still use HDD, SDD is rapidly gaining momentum. Key competitors in the SSD market include Fusion-io (NYSE: FIO), LSI (NASDAQ: LSI), SanDisk (NASDAQ: SNDK) and STEC (NASDAQ: STEC).
Fusion-io is a real up-and-comer and might be an attractive acquisition target for a larger player. LSI bought Sandforce earlier this year to beef up its SDD capabilities. SanDisk recently announced that it is acquiring Pliant Technology, which will increase its position in the market. STEC is one of the leaders in SDD market share and has battled Seagate in the past over patent disputes. These are all formidable foes among several others.
If I had to guess the most likely reason for Seagate’s low price, it would be that some see the SDDs winning over HDDs and doubt the company’s ability to compete in the SDD market. I think Seagate will thrive, though. My main reasons for this opinion are:
- Seagate continues to innovate by making solid-state hybrid drives with near-SSD speeds, large HDD storage and relatively low prices that should be attractive to notebook manufacturers.
- Seagate’s deal with Samsung included a flash memory supply agreement. This helps the company competitively in the event NAND flash memory is hard to come by, which is a distinct possibility. This arrangement also confirms Seagate’s long term commitment to SDD.
- Seagate could and probably will make more acquisitions in the future that improve its position in the SDD market.
What’s the verdict? Seagate is a profitable company with a rock-bottom valuation. The company has plenty of cash and manageable debt with a planned share buyback equating to over one-fifth of its market cap. Growth in its core market looks strong and the company is positioning itself to compete effectively in newer technologies. And I haven’t even mentioned yet that Seagate has a forward dividend yield of 3.8%.
I’m still stumped. I might be missing something, but this company just doesn’t look like a value trap. With a forward earnings yield of over 35%, it looks like pure value. Any stock can perform poorly during uncertain markets like we have currently. However, if you’re a long-term investor looking for a great deal, you probably won’t find many better bargains than Seagate.
Keith Speights (www.keithspeights.com) has no positions in the stocks mentioned above. The Motley Fool owns shares of Fusion-io and Western Digital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.