Risky, Dangerous, Possibly Undervalued Semiconductor Stocks

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From supply chain disruptions to weak volume, data storage producers have taken a beating in terms of performance. Yet strangely enough they have actually done well in recent months for shareholders. Over the last 12 months, shareholder value has gone up 7.5% for EMC, 35% for Western Digital, and 70% for Seagate. The reason is that even bad results have been a relief compared to basement assumptions. But will this bull run continue? Below, I review three stocks with this question in mind.

Seagate Technology (NASDAQ: STX): Not "Dead In The Water" But Highly Risky

Although analysts are calling Seagate dead in the water, you can almost get the business for free at current levels. It trades at 3.5x forward earnings and has a PEG ratio of 0.29x, which indicates that future growth has come nowhere close to being factored into the stock price. Furthermore, free cash flow has risen from $1.6 billion in 1Q12 to $3.6 billion (a 35% yield) in 3Q12 on a TTM-basis. The stock has recovered 89% from its 52-week low. 

There are several reasons why you should still be bearish on the stock. Performance has gotten worse, with a 4% miss in 2Q12 (EPS: $2.41) and a 14.2% miss in 3Q12 (EPS: $1.45). HP's fourth quarter weakness also indicates a challenged hardware market. Operational challenges, seasonality, and large share repurchases could also force the company to cut its 4.6% dividend yield. It is particularly disappointing that earnings have been under expectations despite aggressive share repurchase programs.

During the first quarter earnings call, management cited the following as reasons for poor performance: sluggish macro growth across all major markets, weakened business spending in connection to the fiscal cliff, supply chain adjustments by PC OEMs, and poor notebook innovation. Although the company was able to successfully achieve an efficient equilibrium through shipping ~43 exabyts of storage and maintaining market share, sales volume has come below expectations. This inability to penetrate when the fundamentals are weak, even if it is during a challenging environment, makes Seagate a highly risky stock.

Avoid Western Digital (NASDAQ: WDC), Buy EMC Corporation (NYSE: EMC)

Western Digital's shares plummeted 8.7% after management issued poor 2Q13 guidance. Hard drive demand has been weak, and, unfortunately, there is a lack of catalysts to reverse the trajectory. In fact, Western Digital has confirmed a Citi forecast of 140 million hard drive shipments for calendar 4Q12--a report that was earlier rejected by many as "too bearish". With limited growth prospects, I recommend avoiding the stock. Standpoint Research may still rate the stock a "buy" with a $48 price target, but I encourage avoiding until greater visibility over growth opportunities is attained.

Still, there are fundamentally strong data storage companies out there. EMC trades at 12.9x forward earnings and is forecasted for 13.8% annual EPS growth over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $2.83. At a multiple of 15x, this translates to a future stock value of $42.45. Discounting backwards by 10% yields a present value of $26.36. This is at a slight premium to the prevailing price. With almost no debt on the balance sheet and excellent cash flow, I strongly recommend an investment. The Street, including Cantor Fitzgerald, UBS, and Oppenheimer are calling it a $30 stock or better.

EMC also generates excellent free cash flow. In the twelve trailing months ending 3Q12, $5.8 billion was generated--a dramatic improvement from only $2.1 billion in 3Q07. ROIC of 12.4% also makes the firm a value-creating business during a challenging economic period.

TakeoverAnalyst has no positions in the stocks mentioned above. 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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