The past 12 months have been a bit of a roller coaster for Cupertino-based Seagate Technology (STX, Financial). Having rallied from lows of $40 per share at the beginning of 2018 to highs of around $60 per share during the summer months, the stock is now back to more or less where it started from, trading at $42 per share. The market for data storage is cyclical, so perhaps this should not have come as too much of a shock to investors.
Here is the million-dollar question: Is this a value stock at its current price point, or is the sell-off a harbinger of fundamental changes in the market?
Financials
Seagate currently trades at less than seven times earnings and boasts an attractive dividend yield of 6.02%. The latest earnings report also included much to cheer. On the company’s most recent investor call, interim CFO Kate Scolnick broke down the results:
“Seagate executed well in the September quarter against strong market demand. We achieved revenues of $3 billion, up 14% year over year and up 6% sequentially, consistent with our expectations. Hard disk drive revenues were up 17% year over year, and we are confident that our portfolio is well positioned to monetize cost-effective storage demand.
“For the enterprise hard disk drive market, we shipped 45.5 exabytes, up 67% year over year. In the nearline market, we shipped 42.5 exabytes, and our average capacity per drive exceeded 7 terabytes per drive, up 30% over last year and up 52% from the September quarter two years ago. In addition, we saw stronger than expected demand for our mission-critical portfolio that resulted in 42% year-over-year exabyte growth, with average capacity per drive over 1 terabyte.”
These are impressive numbers, so why the lukewarm reaction? The answer can be found in the underlying forces that shape Seagate’s market.
It’s the NAND, stupid
Within the data storage industry, there are two competing technologies: hard disk drives (HDDs) and solid state drives (SSDs). A HDD relies on an old-school magnetic disk rotating below a read/write head that encodes information onto it, which you will probably recognize if you have ever seen a disassembled computer. SSDs store information on microchips, with no moving parts, hence the name "solid state." There are many differences, but most boil down to the following: SSDs are newer, faster and more expensive, whilst HDDs are older, slower and (until recently) considerably cheaper.
NAND is the main type of flash memory used within SSD memory chips. Therefore, the price of SSDs is directly related to the price of NAND. Historically, the reason that HDDs were attractive to buyers, despite their underperformance relative to SSDs, was the much lower price point. However, the price of NAND has fallen considerably over the last year, and is forecasted to continue doing so, making SSDs available to a wider range of customers than before.
The issue for Seagate is that it has focused relatively little on the SSD part of the market, in contrast to its main rival, Western Digital (WD, Financial). Accordingly, it risks missing the boat on the more widespread adoption of SSDs that is heralded by this fall in prices. This is a problem that may be compounded by Chinese companies looking to corner the market with cheap NAND chips.
It must be mentioned that Western Digital may also suffer as a result of falling NAND prices, as they will exert a downward pressure on the storage giant’s margin. However, Western Digital at least has a sizeable presence in the SSD market, which cannot be said for Seagate, which still relies on sales of the older HHDs, a point that was addressed by CEO Dave Mosely on the recent conference call:
“Now turning to the NAND market, as pricing headwinds and oversupply dynamics persist, we remain committed to our strategic approach to grow our participation in the silicon market and address our customers' storage needs without the overhang from capital requirements and significant cyclical market exposure.
“In the September quarter, we delivered strong sequential revenue growth and began qualifying and shipping selected products with TMC NAND. Along with the rest of the market, we have increased caution over the near-term pricing environment and we are taking some defensive measures, but believe in our opportunities to grow this area of our business over time.”
Verdict
Seagate is trading at attractive prices relative to its historical cycle and has a very good dividend yield. From a technical and historical point of view, it looks like a good buy. But history does not always repeat itself, and there may be fundamental shifts on the way in the data storage market that may prove to be a headache for investors in Seagate going forward.
This article was co-authored by Stepan Lavrouk, director of research at Atreides Capital LLC and a former research analyst for Almington Capital Merchant Bankers.
Disclosure: No positions.
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