Seagate Technology: A Dividend Stock Significantly Undervalued
Frank is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Companies that have strong earnings, great cash flow, and shareholder friendly policies are hard to come by these days. Pair those attributes with one of the cheapest price-to-earnings ratios in tech, and you actually don't have to look as hard as you think. Seagate Technology (NASDAQ: STX), the maker of hard disk drives, fits the bill on all counts. Seagate reported Q3 earnings on Tuesday after the bell. The company crushed analysts expectations, earning $2.48 diluted earnings per share. Seagate's CEO, Steve Luczo, had prophesied of the upcoming Q3 results. Investors who listened were richly rewarded.
The recent rise in shares of Seagate, 50% over the last three months, doesn't mean shares are expensive. In fact, this is one of the cheapest stocks by measure of price-to-earnings that you will find. Even with the recent rise, Seagate trades at only 6.4 times current earnings and just over 4.5 times 2013 expectations. Compare this to the nearly 17 times earnings that the S&P 500 trades at, and you get a stock less than half the price of the overall market.
Seagate has been cheap for a reason. Investors worry that the market for disk drives is dying. Bears argue that the personal computer is going away and new mobile devices using solid state memory will take over. Others don't like the commodity business of disk drive storage. In addition, flooding in Thailand sent shock-waves through the industry last year. Although Seagate's supply chain was affected by the flooding, the company remained relatively unscathed. However, Seagate's top rival, Western Digital (NASDAQ: WDC) was hurt badly by the floods.
All of those arguments raise good points. However, they miss some important facts. The demand for storage is increasing exponentially as more data is loaded into the cloud. Solid state memory is cost prohibitive for cloud storage systems. It's likely that hard disks will continue to serve as the default cloud storage device for many years. Though the hard disk business is a commodity business, competition has been greatly reduced over the last several years. Where there were once eight disk makers there are now three, Western Digital, Toshiba, and Seagate.
While Western Digital has been recovering from the severe blow from the Thai flooding, Seagate has been getting long-term agreements from customers such as Dell. Seagate used the tightness in supply to institute price increases that will likely last beyond the recovery of hard disk shipments. Neither Seagate or Western Digital want to see prices return to the same level they were before the Thai flooding. Despite its woes, Western Digital trades at a higher earnings multiple than Seagate and doesn't pay a dividend. Seagate's margins are actually expanding. The company surprised analysts with 37% gross margins in the latest quarter. The company predicted that margins in fiscal Q4 will be at least 34.5%.
Seagate trades at 1.14 times sales and has a price-to-earnings growth (PEG) ratio of 1.33. Seagate's return on equity (ROE) at 29%, is well above the average of the S&P 500's ROE of 13%. The company's enterprise value-to-EBITDA is a very reasonable 6.62. The company has more than $2 billion ($4.97 per share) on its books and long-term debt of less than $3 billion.
Seagate has been returning cash to shareholders at a very nice clip. The company repurchased approximately 10% of outstanding shares in the third quarter alone. The company estimates that by the end of the calendar year the remaining share count will be down to 350 million from about 440 million today. In addition, Seagate pays a dividend worth 3.6% at today's share price. With a payout ratio of only 26%, there's room for increases.
Seagate operates in a tough industry, but it's the best at what it does. With the upcoming launch of Windows 8 being a potential catalyst, Seagate looks as though it has room to grow. Wall Street hasn't given the company much credit, but investors should. Shareholder friendly Seagate is 'best of breed'.
The Motley Fool owns shares of Western Digital. fjconstantino has no positions in the stocks mentioned above. 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.