Making Hard Cash from Hard-Drives? Keep an Eye on the Pitfalls

By Harsh Chauhan - July 30, 2012 | Tickers: OCZ, STX, WDC | 0 Comments

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When I look at Seagate Technology (NASDAQ: STX) and Western Digital (NASDAQ: WDC) together, I am reminded of The Dark Knight Rises (yeah, I went for the last movie of the Trilogy last week). To understand why, let’s go back one quarter.

The movie begins

Seagate was coming off a great earnings report and the stock recorded impressive gains. Like Batman, Seagate did the hard work of fighting the baddies and exceeding expectations, and like Selina Kyle, Western Digital surged upwards in Seagate’s shadows. But when the time came for Kyle to repay Batman, she deceived him.

Within two weeks of Seagate’s report, Western Digital came out with its own and beat estimates hand down. But a few words of caution from Western Digital CEO John Coyne led to a sell-off and both Seagate and Western Digital went down.

The hard-drive rises

But this time, Batman/Seagate isn’t complaining. Western Digital released its fourth quarter results last week and the stock went up, up and away. And this time, Kyle didn’t leave Batman stranded, as Seagate also reaped the rewards of Western Digital’s outstanding quarter and even more outstanding guidance. Payback indeed! Gotham is saved and crime is wiped out.

Western Digital’s revenue in the quarter doubled to $4.8 billion from last year, including acquisition of Hitachi’s hard-drive business, which it had closed earlier this year. And adjusted earnings, they shot up to $3.35 a share from 81 cents in the same period last year.

If such an astronomical performance was not enough, the company followed it up with an astounding guidance. For the current fiscal year, Western Digital expects to post earnings of $10 per share, far ahead of the $8.06/share consensus.

But the baton has to be passed…

But as I had said earlier, both these companies are enjoying supernormal profits in the aftermath of the Thailand floods and might continue to do so for the next one year or so, if we are to believe analysts at IHS. When there’s no crime in Gotham, what will our superheroes do?

Analysts and brokerages have been raising their price targets and both companies are the blue-eyed boys of investors. Due to the demand and supply inequality created by the floods last year, prices of hard-drives bounced to great heights. This resulted in astronomical revenue and margins. But the question is – for how long? You surely can’t expect such obscene growth for a long time, and when it does stop, the hard-drive players would probably come crashing down.

It’s not easy to gauge for how long hard-drives will be the storage device of choice, but their future is in danger. With personal computers getting thinner and consumers moving to mobile devices such as tablets and smartphones, hard-drives in consumer devices are on the wane. They are being replaced by SSDs and Flash memory. Although hard-drives are still being used in data centers for cloud computing, it’s just because they enjoy the cost advantage over SSDs. Solid-state drives (SSD) occupy less space and are more efficient than traditional drives and are capable of replacing them in the long-term as they are adopted into the mainstream more and more.

…as a new hero is coming through

And SSD costs have been dropping. Industry ace OCZ Technology (NASDAQ: OCZ), which has been making some waves of late, said earlier this year that storage cost per gigabyte on SSDs has gone down to 65 cents from $1 per GB earlier. OCZ also said that the costs can go down even further and challenge the 10 cents/gigabyte cost of HDDs. Moreover, SSD shipments are growing at a terrific pace and are expected to continue doing so, posing a great challenge to HDD’s prospects, and so to Western Digital and Seagate.

And both the hard-drive bellwethers know this pretty well. The rumor mill says that Seagate is courting OCZ Technology with an objective of building its expertise in SSDs and gaining big time with its rapid growth. And this transition will surely come at a price. As sales of SSDs gain more traction due to falling costs and efficient technology, the big boys of the hard-drive industry will find the going tough as their traditional businesses would be in for a downturn most probably.

The takeaway

I have nothing against Seagate and Western Digital. Both of them have been doing brilliantly well so far this year and looks like they are in for at least another year of party. Investors are really elated over how these hard-drive makers are performing. But they should be prepared for a rude awakening when the SSD effect is in full swing and hard-drive makers are forced to reduce their prices, which would probably bring down their revenue, margins and earnings in due course of time.

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