Old Tech Is Still a Buy

Marshall 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) tumbled 15% last week as the hard-disk- drive market is being hit hard by the introduction of tablets and ultrabooks. Since late 2011, the stock is up fourfold. Question is; with the uncertain future of hard disk drives, can Seagate really move any higher?

The news didn’t get any better last week when billionaire David Einhorn of Greenlight Capital announced his hedge fund was closing out its long position in Seagate. Although Einhorn is making an exit, it appears to be more profit taking. As Einhorn notes in his 2Q quarterly letter...

I believe that Seagate is still benefiting from the improved competitive environment, which continues to lead to higher margins. Its operating margin jumped from 7.3% in 2011 to 17.5% over the trailing-12 months.

Seagate is a cash-flow-generating machine, one that pays a solid 3.7% dividend yield; that's a $0.38 quarterly dividend, which is only a 24% payout ratio. Free cash flow is also over $5 per share, a free-cash-flow yield of over 12.5%.

A falling knife?

The latest big pullback in Seagate's stock was after it posted EPS for the quarter ended in June of $1.20 compared to $5.31 for the same quarter last year. The company also only shipped 53.9 million units in the quarter, down from 65.9 million a year earlier.

Disk drives are the key storage devices for desktop, mobile, enterprise, and consumer electronics. Yet, newer technology, such as flash memory, is changing the industry.

However, disk drives are likely to remain the storage solution of choice in enterprise and PC-desktop markets. Gartner expects worldwide HDD shipments to grow at a 5.1% compound annual growth rate from 2011 through 2016.

I like that Seagate has gotten aggressive on the acquisition front. The company bought up Samsung's HDD business at the end of 2011, and also bought an interest in LaCie, a French consumer storage-device maker. To some degree, the acquisitions expand Seagate's reach in HDD, but they also gives it a piece of the SSD market. As well, LaCie's drives are supplied to Apple.

How the comps stack up

Western Digital (NASDAQ: WDC) is expected to see revenue up only 1.9% in fiscal 2014, but fall 1.3% in fiscal 2015. The floods in Thailand allowed Seagate to capture some of Western's market share in 2012. Seagate and Western are in the same boat when it comes to mitigating the downside risks related to the HDD decline. 

Western Digital posted June-ended EPS of $1.96 versus $3.35 for the same period last year but beating consensus handily. The company is developing hybrid drives to help expand its product offering. One of the headwinds for Western Digital is that 45% of its 2012 revenue was from its top-10 customers. 
 
SanDisk (NASDAQ: SNDK) is another major player in the storage market. SanDisk posted 2Q EPS recently, but unlike Seagate, its numbers were up. Earnings per share came in at $1.15 compared to $0.15 for the same period last year. This beat was driven by a strong demand for mobile-embedded products.

Sales are expected to be up 19% in 2013 and another 9% in 2014. The company should benefit from the stabilizing of the flash memory prices and its exposure to the solid-state-drive market. However, SanDisk is seeing increased competition, namely from the likes of Western Digital and Seagate.
 
Most recently, Western Digital snatched up the enterprise SSD maker STEC for $340 million. Like the Western Digital customer concentration, SanDisk gets over 40% of its revenue from its top-10 customers. 

Bottom line

Back in February, there were 36 million shares short  for Seagate, but at the end of June there were only 17 million shares short. The short squeeze that took place has, in part, helped boost the stock price over the last six months. This is a positive. Trading at 8.5 times earnings and paying a 3.7% dividend yield, I still think the stock is a buy and would rather own it than Western Digital or SanDisk. 

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Marshall Hargrave 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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