An Approaching Tsunami for Seagate Technologies?
Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Seagate Technologies (NASDAQ: STX) has been a stock I've covered over the past year. It made Barron’s 10 Stocks for 2012 list and in a December write-up I wholeheartedly agreed and said it was poised to be one of the best performing technology stocks of the year. And boy did it get out the gate.
While everyone was clamoring over the success of Apple (NASDAQ: AAPL) following their dividend announcement, Seagate was exploding. Through the first four months of the year, the stock’s 90% total return more than DOUBLED Apple’s! I recommended ringing the register at the end of the first quarter despite a still favorable view of the name. The timing was a month off and the stock, then at $27, would rise all the way to $32 before falling to its current price in the $24 area.
The 23% sell-off was certainly an attempt to front-run the company’s recent earnings forecast. The company said that fiscal 4Q12 (June) results would see revenues of $4.5 billion against previous guidance of at least $5 billion. Gross margins would also likely miss by a full percentage point. The investing community was somewhat aware of the situation with the stock plummeting and average analyst estimates falling to $2.68 just prior to the company’s release from a high of $2.91 a little more than a month ago. The main culprit to the miss was the company not picking up as much market share gains as they had originally envisioned. For now, they will have to be satisfied with only 42% market share in a duopoly with Western Digital (NASDAQ: WDC) for hard disk drives.
So what now?
I maintain the view that Seagate remains a leveraged bet on global growth. The stock will be very volatile and investors won’t want to ride this stock through a recession, which continues to look like a more plausible situation as the year progresses. I would expect the stock to get crushed in a bear market, but rebound well in advance of any index if U.S. equity markets put in sizable gains. That being said, I personally view the market outlook as one that will witness a sizable bear market in the next 12-18 months and would recommend avoiding Seagate Technologies for now.
Still worth following
Having highlighted my expectation for the stock, it should be noted that for investors seeing nothing but daylight in the equity markets, Seagate makes great sense from a fundamental valuation standpoint. And if it does get hammered in a down market, the underlying business dynamics are such that one would expect a sharp cyclical rebound. Remember the stock lost 90% during the Global Financial Crisis, and then quickly gained more than 500% during the recovery.
Seagate Technologies and Western Digital own more than 80% of the hard disk drive market, a market that is perceived to have a clear downward trajectory as improved substitute technologies and PC maturation take hold. Despite these long-term headwinds, investors are poised to benefit amid the duopolistic industry structure and a longer tail of steady cash flow generation than many industry forecasters predict.
The stock has many favorable attributes such as a 5.5x price-to-earnings multiple and a 4% dividend yield. The company has a double-digit dividend growth rate and a modest payout ratio that supports continued dividend increases. Dividend growth is driven by the steady cash-generating abilities of the company. Although volatile, the company has a free cash flow-to-sales ratio of 16% and a free cash flow-to-enterprise value of 18%, both off the charts. Absent a sharp deceleration in earnings from a competing technology, this newest member of the S&P 500 is one of the cheapest in the Index by large margin.
Seagate Technologies, like many other companies, is facing the prospect of slower than expected earnings growth. The stock remains a great choice for fundamental investors with a bullish outlook on the U.S. equity market, but beware the volatility. If you are looking to de-risk, then it is time to sell. Regardless of one’s current view, you are going to want to want own this stock when the next cyclical bull market roars.
market8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Western Digital. Motley Fool newsletter services recommend Apple. 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.
