Don't Fear the Uncertain Future of This Company's Technologies

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Seagate Technology (NASDAQ: STX) has performed very well lately, with shares up by around 30% year-to-date. The last time I wrote about Seagate was in late January, and I wrote about how undervalued the company was at the then-current share price of around $36. Fast-forward about six months, and while it appears that I was correct on a short-term basis, I’m in this game for the long haul! With the company set to report earnings on Wednesday, July 24, now may be a very opportune time to revisit Seagate and see whether it is still a bargain ahead of earnings, or whether investors should take profits and look elsewhere.

A bit about Seagate…

One of the world’s largest makers of hard drives, Seagate released the first 5.25” hard drive in 1980, with a whopping 5 MB (yes, that’s megabytes!) of capacity. The company has evolved with the technology, and has done very well, announcing in March that it had shipped its 2 billionth hard disk drive. 

Seagate has been an industry leader over the years, being the first to introduce high-speed hard drives to break the 7,200 (in 1991), 10,000 (in 1996), and 15,000 (in 2000) rpm benchmarks. More recently, the company has been breaking capacity records and in late 2011 introduced the first 4 TB single disk hard drives.

The main concern in regards to Seagate’s future is the transition to solid-state storage, but Seagate seems to be emerging as an industry leader in this area as well. While the majority (around 80%) of Seagate’s sales comes from traditional hard drives, this is a legitimate cause for concern, but I think that traditional hard drives will rule the market for a few more years, at least until solid-state drives become a bit more cost-efficient. Seagate has been a pioneer so far, producing the first hybrid drive and now has a complete lineup of hybrid and fully solid-state drives. However, it is the uncertainty of the future of this sector that has caused Seagate to trade at a very attractive value in the past.

The numbers still look good

Even after the incredible gains of not only this year, but the past few years (Seagate trades as low as $2.98 per share in 2009), Seagate still looks very cheap. Shares trade for just under 9 times 2013’s expected earnings of $5.29 per share, which has been revised upward since my last article on the company. The consensus calls for earnings to grow to $5.46 and $5.84 per share in 2014 and 2015, respectively, but this is a very loose usage of the word “consensus.” Analysts are very much in disagreement when it comes to Seagate’s future, with estimates varying widely. For example, in 2015, analyst estimates range from a low of $4.13 per share to a very bullish prediction of $7.43 per share. 

It is this uncertainty that is causing Seagate to trade for such a low P/E. Additionally, Seagate is one of the best dividend payers in the tech sector, currently yielding 3.2%. The company also has an aggressive share repurchase program that has been a huge driver of value. In fact, since 2010, the total number of outstanding shares has dropped from 514 million to 358.6 million, a staggering 30% reduction in just three years.

Looking at the alternatives

There are many players in the hard disk and storage business, but only a few with the size and products to make a reasonable comparison to Seagate. Western Digital (NASDAQ: WDC) and SanDisk (NASDAQ: SNDK) are two that have gone about adapting to the changing computing environment in different ways.

Western Digital is roughly the same size as Seagate in terms of market cap and became the world’s largest manufacturer of traditional hard disk drives after acquiring Hitachi Global Storage Technologies last year. The company trades at an even cheaper valuation of 8.4 times this year’s expected earnings, but I prefer Seagate for two reasons. First, Western Digital pays a much lower dividend yield of 1.43%.  Second, I really like Seagate’s history of innovation. In terms of the quickest, biggest, and best hard drives, Seagate tends to get there first, which is huge in the technology sector. 

SanDisk is about the same size, but has a much different product line. SanDisk designs and develops flash memory products only, such as SSDs, memory cards, flash drives, and more. As there is much less concern about the future viability of SanDisk’s products, shares trade at a higher (but still reasonable) valuation of 13.5 times 2013’s earnings. This is not quite an apples-to-apples comparison, but I wanted to mention one of the pure flash-memory plays to show the power of market uncertainty when it comes to valuing companies.

Buy, sell, or hold?

Although it is not quite the bargain that it was six months ago, Seagate is still a very good value, and is absolutely the best-in-breed when it comes to traditional hard disk drive manufacturers. While it is completely reasonable for those who have held through all of the recent gains to sell some of their position and take profits, Seagate should provide great returns for its shareholders for years to come and deserves to be owned.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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