Seagate (STX, Financial), which designs, manufactures, and sells electronic data storage products, has moved higher by 45% in the last one year. This article discusses why the rally is not over and why Seagate is an excellent long-term investment.
From a fundamental perspective, Seagate has a solid track record and it underscores the company’s management efficiency. The company’s revenue has increased at a CAGR of 2.5% to $14.4 billion in FY13 from $12.7 billion in FY08. The net income growth has been more impressive during the same period with the net income increasing at a CAGR of 8%.
The company’s diluted earnings per share have increased at a CAGR of 15.6% during the same period and the robust increase in EPS is primarily due to share buybacks. I also like the fact that Seagate has a very strong operating cash flow with the company’s OCF at $3 billion as of 2013.
With a capital expenditure of $786 million for 2013, the company has a free cash flow in excess of $2 billion and this gives immense scope for Seagate to increase dividends and go for further share buybacks. Seagate did return 70% of the operating cash flow to shareholders in 2013 and I believe that strong shareholder returns will continue to create immense value.
Another reason for liking Seagate is the fact that the company offers a dividend yield of 3.1% considering the current annualized dividend of $1.72 per share. Given the strong cash flows, Seagate intends to increase its dividends at 10% on an annual basis and this is certainly attractive for investors looking for a good dividend stock with bright growth prospects.
I believe that the prospect for the company is bright over the long-term considering the demand for storage over the next few years. As the chart below shows, the demand for storage is expected to increase significantly and the storage industry output is lagging. To close this demand-supply gap, the growth for companies like Seagate is expected to be robust over the next few years.
Seagate has also been active in terms of inorganic growth and a strong operating cash flow and low debt allows the company to pursue attractive acquisition opportunities. In May 2014, Seagate acquired the assets of LSI’s Accelerated Solutions Division and Flash Components Division from Avago (AVGO) for $450 million in cash.
The acquisition strengthens Seagate’s strategy to deliver a full suite of storage solutions, providing Seagate with established Enterprise PCIe flash and SSD controller capabilities to deliver solutions for the growing flash storage market.
In March 2014, Seagate also completed the acquisition of Xyratex. Seagate expects revenue contribution from this acquisition to be between $500 and $600 million for FY15. Therefore, the growth potential from acquisitions is also significant and will continue to add value for shareholders.
With these acquisitions and through organic growth analyst estimates suggest that earnings growth for June 2015 and June 2016 will be 11.4% and 10.6% respectively. Further, the company’s five year expected PEG ratio is currently at 0.93, which suggests that the stock is undervalued.
Further, SanDisk (SNDK, Financial), which can be considered as close peer, is trading at a forward PE of 14.0 as compared to a forward PE of 10.0 for Seagate. Even on an EV/EBITDA basis, SanDisk is trading at an trailing twelve month EV/EBITDA of 8.7 as compared to 7.7 for Seagate. Therefore, Seagate looks attractive on a relative basis. Seagate’s Peter Lynch chart also suggests that the stock is undervalued at a current price of $59.5, with the Peter Lunch chart suggesting a value of $67.8.
Therefore, Seagate is a high dividend yield stock with robust growth prospects and is trading at attractive valuations. Investors can consider this stock with a medium to long-term investment horizon. With over 10% earnings growth expected over the next two years, Seagate is likely to increase its dividends further and the stock is also likely to move higher.
