Buy, Sell, or Hold Seagate?

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If you see a Ferrari selling for Honda Accord prices, the first instinct is to ask what the catch is. So, when I was perusing my watch list recently and saw Seagate Technology (Nasdaq: STX  ) was trading at just under five times its trailing free cash flow, I was immediately suspicious. After all, Seagate is a leader in hard-drive technology, and while it has been slower than some rivals to enter new growth areas such as solid-state drives; its fundamentals look solid.

To better sort out the Seagate pricing mystery, here's a series of reasons to buy, sell, or hold the company.

Compelling valuation: Allow me to reiterate: It's trading at less than five times trailing free cash flow! That's a pretty low value for an industry leader. Not only that, but all that cash produced over the last year has allowed Seagate to fortify its balance sheet for harder times. The company now has more cash on hand than total debt. Better yet, new management has managed to squeeze out a bloated cost structure, which should help ensure the company can keep up high cash flow once constrained supplies clear up and competition intensifies.

Commodity product at a peak: There's little that separates the hard drives of Seagate and main competitors Hitachi, Toshiba, and Western Digital (NYSE: WDC  ) . With Western Digital picking up market share and eyeing Seagate's enterprise stronghold, competition should intensify. If industry capacity increases and there's any economic downturn, hard-drive makers could suffer through some brutal oversupply and pricing battles once again.

Solid-State Drives (SSDs): The huge question mark in Seagate's business. Solid-state drives don't require moving parts like the traditional hard drives Seagate generates nearly all its revenue from, and they have several other benefits such as less power consumption. However, they're also more expensive. The SSD field is full of competitors. SanDisk (Nasdaq: SNDK  ) , STEC (Nasdaq: STEC  ) , and Intel (Nasdaq: INTC  ) are all working to carve out their own niche across the consumer and enterprise flash memory market. Also, yes, the market for SSDs should continue to grow at a dramatic pace in coming years. Make no mistake, competition is fierce, and Seagate is coming from behind. However, even with the rise of SSDs, Seagate should still see robust demand within the enterprise, an area of staggering data growth that will still demand cheap options for storing massive amounts of data. Given the price difference between Seagate's bread-and-butter magnetic drives and newer SSDs, Seagate still has a long run before SSDs eclipse hard drives.

The final call
At $14 per share, Seagate looks like a steal. The buy considerations definitely outweigh the sell and hold risk factors. Don't let the SSD boogeyman scare you off at these prices; there's enough life left in traditional hard disk drives that Seagate should be a winner.

Eric Bleeker owns shares of no companies listed above. Intel is a Motley Fool Inside Value selection. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended buying calls on Intel. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (3) | Recommend This Article (16)

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  • Report this Comment On July 13, 2010, at 1:01 AM, rbishnoi wrote:

    Both Seagate and Wester Digital look undervalued however I find Western Digital just a bot more undervalued. Here's how I see it:

    1. WDC has 5.5 trailing PE vs 6.37 for STX. [1-0]

    2. STX has est fwd PE of 4.26 vs 5.25 for WDC. [1-1]

    3. More analysts expects WDC to have better growth in next 5 years (16 vs 10) [2-1]

    4. WDC has been vertically integrating for some time and arguably have the best low cost structure which means lesser impact of price compressions in times of over supply and reduced demand. WDC's margin is already better than STX and improving. [3-1]

    5. WDC sells for 31.x and has 1.2x in cash with virtually no debt. STX had some debt although manageable. Cash adjusted trailing PE for WDC is 3.36 vs 4.42 for STX. [4-1]

    6. With their early acquisitions, WDC is better positioned for future which is SSDs and flash. [5-1]

    7. STX leads enterprise market whereas WDC leads consumer one. I believe WDC's push to enterprise will be more successful vs. STX's in consumer market. I would give this one to STX due to high margin in enterprise market. [ 5-2].

    I own neither WDC nor STX but have a little bias towards WDC (not sure why) however I would love to hear more opinions on STX's case.

  • Report this Comment On July 13, 2010, at 9:48 AM, TMFRhino wrote:

    Hey rbishnoi,

    You make some great points. I'm fairly agnoistic between the two, but WDC's balance sheet is a pretty key advantage if the economy turns again.


    Eric Bleeker (TMFRhino)

  • Report this Comment On July 19, 2010, at 9:00 AM, discwizard wrote:

    Hi Eric,

    very good analysis. "Seagate is trading at less than five times trailing free cash flow! That's a pretty low value for an industry leader". Very soon there should be robust demand and at current price STX is a steal. I am afraid cant say the same for WDC.

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