Two Hard Drive Manufactures For Big Profits

By Chad Henage - February 7, 2012 | Tickers: STX, WDC | 0 Comments

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After constantly hearing about how flooding overseas is causing hard drive shortages, I wondered, is there opportunity here? The crisis of today can be the opportunity of tomorrow. It seems history is repeating itself with two hard drive manufacturers I've found. No matter what you think of the PC industry and the future of storage, these two companies are cheap. The two companies I'm referring to are Seagate Technology (NASDAQ: STX) and Western Digital (NASDAQ: WDC). 

I understand that both companies face some supply issues short term, but these won't last forever. In addition, even with the huge push towards tablets and smartphones there are millions of standard hard drives being sold. In particular, as more music, pictures, and video become digital there is a need to store all of this somewhere. Larger sized external hard drives have become more cost effective as a backup solution. Since Seagate and Western Digital are two of the biggest players in the game, let's see just how cheap these stocks have become.

As you can see the market isn't giving much credit to the analysts that follow either company. Many times companies that sell at this cheap of a PEG ratio have underlying problems. Let's check a few other metrics for each company, and see where they have been and how they have been doing.

(Avg. Cash Flow = (Operating Cash Flow last 4 quarters – Capital Expenditures last 4 quarters) / 4) Average Cash Flow / Total Assets = Avg. Cash Flow per Dollar of Assets) 

Previous EPS Growth

We can see Seagate has shown declining earnings in the past few years. This could be cause for concern because analysts are expecting over 24% growth going forward. This is a classic turnaround story. Analysts are expecting the company to not only recover from its past issues, but show significant growth going forward. Where Western Digital is concerned, their past growth of 13.23% makes their future growth expectation of 11.60% very reasonable.

Average Earnings Beat

Both companies have been beating analyst estimates by a decent margin. Seagate has beaten estimates 3 of the last 4 quarters by an average of 9.12%. Western Digital has beaten estimates 3 of the last 4 quarters by an average of 37%.

Avg. Cash Flow per Dollar of Assets

This is a good comparison tool for two companies in the same industry. The company that generates more free cash flow per dollar of assets is the more efficient operator. We can see that Seagate generates average quarterly free cash flow of just over 1 cent of per $1 of assets. Western Digital on the other hand generates average quarterly free cash flow of nearly 3 cents per $1 of assets.

All of these numbers are a starting point for further research. Both companies appear attractively priced if analyst estimates can be believed. Each company has been beating previous earnings estimates. Seagate is more of a turnaround play. Western Digital is more of a middle of the road growing company. If Seagate is able to meet estimates going forward this should be closer to a $150 stock. With a PEG of 1 and a growth rate above 24% that would not be unreasonable. I believe that analysts are probably being a little too generous, but even if they are off by 50% the stock could be worth $75. Where Western Digital is concerned the company looks undervalued, but not as dramatically as Seagate. Western Digital with a PEG of 1 would sell for about $65.

These two companies in the same industry, are potentially undervalued by 181%+ (Seagate) and 69% (Western Digital). I believe both will outperform the market over the next few years. I'm making my CAPSCall with a thumbs-up on both today. Check into each company, and see whether you might want to save some of their stock for your portfolio.

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