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.