Time to Sell Seagate Technology?
Justin 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) reported strong 2QF12 results and gave blowout guidance. The shares are up more than 22% on the beat. The company was one of Barron’s 10 stocks for 2012 and I gave my praise for their recommendation here. Since the beginning of the year, the stock is up more than 50% and investors that followed that advice have been well rewarded. I likely wouldn’t recommend buying into the name now, but would instead take a neutral view of the stock. I think it will continue to bleed up and outperform the market thanks to recent industry dynamics.
The company is a leader in the hard disk drive market, which is used in PCs, servers, laptops, and some entertainment devices. 2QF12 EPS came in at $1.28 compared to $0.31 a year earlier. Revenue guidance for calendar 2012 was a whopping $20 billion, a notable upside to consensus estimates at $17.5 billion. This essentially stems from unsustainable pricing due to supply disruptions caused by the Thailand floods.
Industry Dynamics
There are essentially two forces pulling in opposite directions regarding the outlook for the company. First off is the serious industry consolidation. Seagate just completed its purchase of Samsung Electronics HDD business and competitor Western Digital (NASDAQ: WDC) bought Hitachi Global Storage Technologies. This makes Western Digital a much more formidable competitor in Seagate’s enterprise division, but it essentially creates a duopoly. I would expect pricing to be rational going forward.
The second dynamic is the technological destruction potential in the HDD market. Eventually solid state drives (SSDs), which cost more than 5 times the price of HDDs will become more competitive and their performance advantages will warrant a transition in the industry. This is a real threat to the company.
Valuation
Fundamentally speaking, I would give Seagate a neutral-plus rating. The price-to-earnings ratio is at 11x and in-line with ten-year averages. The price-to-sales ratio at 1x is also in-line with ten-year average and right in the middle of the range of 0.5x to 1.5x. That is the neutral component.
The plus component is the dividend story. The company pays an above average 3.87% yield. They have a solid dividend growth profile with a five-year average growth rate of 14%. The payout ratio is also a modest 13%. While this is a very cyclical, commodity-like business, there is plenty of opportunity to increase dividends to shareholders with such a large margin of safety built into the payout ratio.
Bottom Line
Investors should tread carefully with Seagate. I personally think the tail - high prices in near-term and SSD fears further away than expected - will be longer than consensus expectations. The valuation story is moving toward neutral from undervalued and I think it will maintain that momentum until it eventually reaches overvalued levels later this year. That would be an ideal time to sell. Having said that, I can’t argue with those that think 50% upside in a month in a commodity-like business is good enough.
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