Can Profits Be Archived? A Look at Data Storage

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With cloud storage turning into the new star of the digital era, what is the future for hard disk drives (HDD)? I do not like to think that one innovation erases competitors from the picture. I prefer to think that new technologies offer another possibility to accomplish our everyday tasks. So, let's look into three data storage market leaders: EMC (NYSE: EMC), Western Digital (NASDAQ: WDC), and Seagate Tech Ireland (NASDAQ: STX).

Turning the wheel

Seagate currently holds around 40% of the HDD market. Sales volume has suffered due to Thailand's flood, and high uncertainty continues to cast gloom over the market. The company will also face tougher competition from alternative technologies. In the meantime, a growing demand for PCs and game consoles is expected to offset negative trends.

Seagate has developed hybrid drives in order to counter the effect of solid state drives (SDD) in ultrabooks and other alternative technologies. The introduction of new products and the upcoming holiday season is expected to return the company to previous performance levels and secure long-term growth.

So far, the market has proven that SDD technology will not eat out of the HDD market because SDD carries a higher price and holds less information. As a result, the future outlook for the company remains positive. Analysts still have a great deal of uncertainty about the industry, however.

Lower shipping volumes due to the flood means bad news for Seagate, but at the same time it allows for price hikes. It's also fortunate that no facilities have been damaged. The company continues to buy out smaller and troubled competitors in an effort to increase market share, and it has done so successfully since 1989.

Seagate has also started a relationship with Virident Systems that will allow the firm to venture into the peripheral component interconnect express segment. At the same time, it is concentrating on efforts to cater to the enterprise side of the business that offers better future prospects.

Financially, Seagate is very strong. Trading at 7.2 times its earnings (a 56% discount to the industry average) and paying a dividend of $0.38 dividend, the stock is undervalued. It is recommended to buy because the company took decisive steps to develop alternative storage devices like SSD, RAID arrays, and optical drives.

Research issues

Western Digital´s facilities have suffered from Thailand's flood as well, which offset demand increases, reduced price leverage, and stronger shipping. Future prospects, however, remain positive thanks to the introduction of new products and strategic acquisitions.

New products have been focused in the SDD and HDD segments, while ongoing research has concentrated on products for large data centers. The company looks to benefit in the long run from the increasing number of data centers, being pushed by cloud-based storage.

Like its main competitor, Seagate, Western Digital is expected to benefit from a higher demand for desktop and notebooks in the second half of 2013. Benefits are expected to become visible in the long-term as suppliers adjust their inventories.

The most important characteristic for Western Digital´s long-term growth, however, is the fact that almost half of its revenues originate in the Asian market. Given current market synergies, India and China offer the company a great future outlook.

Western Digital's balance sheet is very strong. The company trades at 8.2 times its earnings (a 48% discount to the industry average) and pays $0.25 quarterly dividends. It is recommended to hold until R&D expenses are curbed, customers become more diversified, and Thailand´s assets are fully operational, however.

Acquisition spree

EMC is the only company here that has improved revenues, though this was at the cost of its operating margins. Acquisitions and competition have further reduced potential profits as well. For the road ahead, a wide portfolio that serves all segments is expected to guarantee profitability.

EMC provides both storage hardware and software. As a result, the firm will no doubt absorb a great part of the market synergy generated by higher demands for data center and cloud-based storage. At the same time, by providing hardware and software the company has risen switching costs, turning into a respectable rival for giants like IBM, HP, and Dell.

In order to further capitalize on market synergies, EMC has acquired 17 companies and increased its presence in emerging markets. Such acquisitions have increased potential profits by vertically and horizontally integrating the company, promoting efficiency and lowering its bottom line. The company also started several partnerships.

On the downside, the aggressive acquisition spree has risen some red flags. Its pricing leverage is small given high competition, limiting possibilities for the company's margin expansion. One example of such a risk is the as-yet unprofitable VCE partnership with Cisco.

EMC has a clean balance sheet, and holds the highest operating margin in the industry. The stock currently trades at 21.3 times its earnings, packing a 25% premium to the industry average. It is recommended to hold until recent acquisitions and issues with Cisco are resolved.

Storing it away

Industry competition will continue to stiffen, but the three companies analyzed here have secured large market shares. Future profits will deepen as new products are introduced; this is especially true for Seagate. While Seagate is not the greatest innovator, it has learned to balance research and finances. Additionally, its acquisitions have been measured and are improving the company's overall performance.

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patricio kehoe has no position in any stocks mentioned. The Motley Fool owns shares of EMC and 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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